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Entity Selection: From Sole Proprietorship to Corporation

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The Forms and Activities of Business Organizations: A Comprehensive Guide

A business organization is a structured entity formed to engage in commercial, industrial, or professional activities with the goal of generating profit or fulfilling a social mission.

Understanding its legal forms and core activities is fundamental to grasping how economies function. This guide expands on the three primary activities and provides detailed examples of each business type.

Part 1: The Three Core Activities of Any Business Organization

Regardless of size or industry, every business engages in three fundamental activities. These form the core of its operations and financial tracking.

1. Operating Activities
These are the principal, revenue-generating activities of the business. They involve the core functions of producing, selling, and delivering goods or services.

Includes: Revenue from sales, payments to suppliers and employees, rent, utilities, and marketing expenses.
Financial Reflection: Directly impacts the Income Statement (Profit & Loss Account). Positive cash flow from operations is a key indicator of health.
Example (Cafe): Selling coffee and pastries, buying coffee beans, paying barista salaries, and covering the electricity bill.

2. Investing Activities
These activities relate to the purchase and sale of long-term assets and investments not intended for immediate resale. They are crucial for sustaining and growing the business's capacity.

Includes: Purchase or sale of property, plant, equipment (PP&E), acquisition or sale of other companies or securities, and loans made to others.
Financial Reflection: Tracked in the investing section of the Cash Flow Statement and affects the Balance Sheet.
Example (Manufacturer): Buying a new factory building, selling an old delivery truck, or purchasing a patent for a new technology.

3. Financing Activities
These activities involve transactions with the business's owners and creditors. They show how a business funds its operations and growth.

Includes: Issuing shares (equity), paying dividends, borrowing money (loans, bonds), and repaying debt principal.
Financial Reflection: Found in the financing section of the Cash Flow Statement and impacts the equity and liability sections of the Balance Sheet.
Example (Tech Startup): Raising capital from venture capitalists (issuing shares), taking out a bank loan, or later paying dividends to shareholders.

Interconnection: A successful business uses cash from operating activities and financing activities to fund investing activities, which in turn should improve the efficiency and scale of future operating activities, creating a virtuous cycle.

Part 2: Three Types of Businesses According to Primary Activity

Businesses are categorized based on their primary revenue-generating operation. This classification affects their accounting, inventory management, and cost structure.

1. Service Concerns
These businesses sell intangible products, expertise, time, skills, or experiences. They do not hold physical inventory for sale.

Key Characteristics:
Revenue is generated through fees, commissions, or subscriptions.
Primary inputs are labor and knowledge.
Inventory is minimal or non-existent.
The income statement typically shows "Service Revenue" and focuses heavily on labor and overhead costs.
Detailed Examples:
Professional Services: Law firms (e.g., DLA Piper), accounting firms (PwC), consulting firms (McKinsey & Company).
Personal Services: Hair salons, fitness trainers, therapists, dog walkers.
Financial Services: Banks (JPMorgan Chase), insurance companies (State Farm), investment advisors.
Creative & Technical Services: Marketing agencies, software development firms (GitHub), architectural firms.
Hospitality & Experience: Hotels (Marriott), restaurants (though they sell tangible food, the core value is the dining experience and service), movie theaters.

2. Merchandising / Trading Businesses
These are the "middlemen" of commerce. They purchase finished goods from manufacturers or wholesalers and sell them to consumers without altering the product.

Key Characteristics:
Core activity is buying and selling.
They hold physical inventory (also called "merchandise inventory").
Profit comes from the markup (the difference between cost of goods sold and sales price).
Accounting requires a Cost of Goods Sold (COGS) calculation.
Detailed Examples:
Retailers (B2C): Walmart (sells everything from groceries to electronics), Nike retail stores, your local bookstore, Amazon (as a retailer of its own inventory).
Wholesalers & Distributors (B2B): Companies that buy in bulk from manufacturers and sell smaller quantities to retailers. Example: Sysco, a major foodservice distributor that supplies restaurants and cafeterias.
E-commerce Pure Plays: Online-only retailers like Zappos (shoes) or Chewy (pet supplies).
Car Dealerships: They purchase finished vehicles from manufacturers (Ford, Toyota) and sell them to consumers.

3. Manufacturing Concerns
These businesses create tangible products. They convert raw materials and components into finished goods using labor, machinery, and factories.

Key Characteristics:
The most complex operation, involving procurement, production, and sales.
Holds three types of inventory:
1. Raw Materials: Basic inputs (steel, wood, plastic).
2. Work-in-Process (WIP): Partially completed goods on the factory floor.
3. Finished Goods: Completed products ready for sale.
Accounting involves detailed product costing to allocate material, labor, and manufacturing overhead to each unit.
Detailed Examples:
Consumer Goods: The Coca-Cola Company (beverages), Procter & Gamble (detergents, diapers), Samsung (electronics).
Automotive: Toyota, BMW. They assemble thousands of parts into a finished vehicle.
Aerospace & Defense: Boeing (airplanes), Lockheed Martin.
Pharmaceuticals: Pfizer, manufacturing medicines from chemical compounds.
Food Processing: Tyson Foods, turning livestock into packaged meat products.

Conclusion and Integration

The form (activity type) of a business directly dictates how it conducts its three core activities.

A merchandiser like Walmart:
Operates by purchasing goods from thousands of manufacturers and selling them at retail.
Invests in vast distribution centers, retail store footprints, and inventory systems.
Finances its massive inventory purchases through a mix of operating cash flow and supply chain financing.

A service concern like Netflix:
Operates by licensing/building content and delivering it via streaming for a subscription fee.
Invests in technology infrastructure (servers) and intellectual property (content).
Finances its massive content investments through subscriber revenue and debt issuance.

Understanding these categories and activities provides a clear framework for analyzing any business's strategy, financial statements, and economic role. Whether producing goods, trading them, or providing essential skills, each type is a vital component of the global economic ecosystem.

The key insight is that form dictates function, the legal/operational structure of a business fundamentally shapes how it executes its core activities.

1. Software-as-a-Service (SaaS) Company: Salesforce
Form: Cloud-based, subscription software company.
Core Activity 1: Sourcing & Production (How it builds the platform)
How: "Production" is software development and server infrastructure. It sources talent (developers, engineers) and cloud computing power (AWS, its own data centers). The core "factory" is its codebase and global server network.
Core Activity 2: Sales & Distribution (How it reaches the customer)
How: A mix of direct online sales (self-service) and a massive, direct enterprise sales force. Distribution is instantaneous—access is granted via the internet. Relies on freemium models and tiered subscriptions.
Core Activity 3: Innovation & Service (How it improves and supports the platform)
How: Continuous, iterative software updates deployed to all users simultaneously. Customer success teams are core to retention. Innovation is driven by user data and feedback loops, with new features released quarterly.

2. Franchise Model: McDonald's
Form: A franchisor (corporate) that licenses its brand and system to franchisees (owner-operators).
Core Activity 1: Sourcing & Production (How it makes the product)
How: Corporate designs supply chain and negotiates with approved suppliers (e.g., Coke, beef patty producers). Production (cooking/assembly) is executed by franchisees in locally-owned restaurants according to strict corporate specifications.
Activity 2: Sales & Distribution (How it reaches the customer)
How: Distribution is via thousands of independently-owned but uniformly-branded physical locations. Sales are hyper-local, but marketing, menus, and promotions are centrally controlled by corporate.
Activity 3: Innovation & Service (How it improves and supports the product)
How: Corporate R&D develops new menu items and equipment (e.g., touchscreen kiosks). Franchisees implement them. Service quality is managed through training programs and operational audits, but daily execution is the franchisee's responsibility.

3. Platform/Marketplace: Airbnb
Form: A asset-light digital platform connecting two user groups (hosts and guests).
Activity 1: Sourcing & Production (How it "creates" the inventory)
How: It does not own or produce physical assets. It "sources" by incentivizing individuals (hosts) to list their properties. Its "production" is building the tools and trust systems (verified photos, insurance) that make private assets bookable.
Activity 2: Sales & Distribution (How it reaches the customer)
How: A digital two-sided marketplace. It distributes access via its app and website, using algorithms to match guests with listings. Its core sale is facilitating the transaction and taking a commission.
Activity 3: Innovation & Service (How it improves and supports the platform)
How: Innovation focuses on platform features (e.g., Experiences, split-stays), search algorithms, and trust/security systems. "Service" is primarily dispute resolution, customer support for both sides, and maintaining community standards, not physical maintenance.

4. Pharmaceutical Company: Pfizer
Form: Research-intensive, highly-regulated pharmaceutical company.
Activity 1: Sourcing & Production (How it makes the product)
How: Sources chemical compounds and biological materials. Production occurs in FDA-approved, sterile, and extremely expensive facilities. The process is defined by rigid "Good Manufacturing Practices" (GMP) with immense focus on batch consistency and purity.
Activity 2: Sales & Distribution (How it reaches the customer)
How: Sales target are not end-users but doctors, hospitals, and insurance companies (payers). Distribution is through a complex web of wholesalers and pharmacies. Price is negotiated with insurers and governments, not set directly for consumers.
Activity 3: Innovation & Service (How it improves and supports the product)
How: Innovation is driven by decade-long, multi-phase clinical trials overseen by regulators (FDA, EMA). "Service" includes extensive post-market surveillance, medical information for doctors, and patient assistance programs. Incremental product updates are rare; new products require entirely new R&D cycles.

Conclusion:
Changing the form (SaaS, Franchise, Platform, Pharma) completely alters the mechanics of each core activity. The what (a product/service for a customer) may be similar, but the how is defined by the business's fundamental structure.

Choosing a Business Structure

There are numerous kinds of organizations that can be separated into two major divisions: organizations existing to create profits (profit organizations. Includes business entities) and organizations that exist primarily for another purpose (non-profit organizations. E.g: charity organizations). 

3 Types of Business Entities and their common characteristics: 

1. Sole Proprietorships. Sole proprietorships are business that are owned and operated by one person: the sole proprietor. The owner and the business, is then the same. For tax purposes, a sole proprietorship is not a taxable entity, and any profits earned by the business are taxed on the return of the individual.

The proprietor must develop an accounting system that distinguishes between his/her personal affairs and that of the business.

2. Partnerships. Partnerships are businesses that are owned by two or more individuals. For small partnerships, the agreement is often an oral agreement between the partners but it is highly recommended that the agreement be formalized as is done in bigger partnerships like public accounting firms and most law firms. In partnering up with individuals, it is important to outline the division of profits and expenses, as well as the expected responsibilities of the partners in a written agreement. 

3. Corporations. A corporation is an entity organized under the laws of a particular state. That means that it can get into contractual agreements in its own name. They are identifiable by the existence of shares. There are advantages and disadvantages of each of the above types of business entities. And each is suited to the same business under different stages of its growth. For most, arts and entertainment independent contractors, it is probably Sole Proprietorships and Partnerships that are most common for their use. 

Non-Business Entities. Most non-business entities are organized to serve the needs of various segments of society. Examples of these non-business entities are public hospitals, public schools, the police and the army. All of these entities are distinguished by the lack of an identifiable owner. Because of this and the non-profit motive to these organizations, their accounting systems are modified to fit their activities. The type of accounting they use are referred to as fund accounting. You should still seek professional advice regarding the matter because laws and practices change over time and they differ from country to country.

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