Fundamental Concepts and Environment of Business Organizations in the Basic Business Environment
The Definition and Fundamental Nature of Business
The term business carries diverse meanings depending on the perspective of the individual. For some, it represents dreams of excitement and opportunity, while for others, it symbolizes greed and exploitation. Regardless of these subjective views, the world of business impacts every individual daily. Lexically, the dictionary defines business as one's work or occupation, a special task or duty, a matter or affair, commerce or trade, or a commercial or industrial establishment. In the context of business studies, it specifically refers to commerce or trade as a whole or a specific company engaged in those activities.
At its core, business is defined as the process of producing (manufacturing) goods (products) and services and subsequently distributing (selling) them to those who desire or need them. This simple definition encompasses both private and government-run organizations that deliver goods and services to individuals within the marketplace.
The Four Factors of Production
To produce goods and services, a society must utilize four essential factors of production. The way these factors are combined is determined by the society's utilized economic system. The four categories are defined as follows:
Natural Resources: These include land and the materials derived from it, such as timber, mineral deposits, oil deposits, and water.
Labor (Human Resource): This encompasses the mental and physical efforts provided by all workers, irrespective of their education level or specific skills, to perform the tasks necessary for production and sales.
Capital: This factor consists of the buildings, machinery, and tools required to produce goods and services. The term is also used to refer to the money required to purchase these physical items.
Entrepreneurship: This factor represents the individuals willing to accept the opportunities and risks involved in starting and managing a business. Entrepreneurs act as the catalyst that brings natural resources, labor, and capital together to form a functioning business entity.
Principal Objectives and Social Responsibilities of a Business Firm
The fundamental objective of any business firm is to produce goods and services that meet the needs and desires of customers while doing so at a profit. This primary goal is inextricably linked with several social responsibility objectives. Profitability is viewed as prime evidence that a firm is effectively meeting customer needs and provides the necessary assurance that the business can sustain its existence over a long duration.
Social responsibility objectives include protecting the health and well-being of employees, who are recognized by wise owners as the firm's most valuable asset. This involves providing competitive salaries, safe and healthful working conditions, and desirable surroundings. Further protections include workers' compensation laws for on-the-job injuries, pension plans, vacation time, and profit-sharing arrangements. These developments are often driven by both internal realization and external pressure from unions and the public.
Exercising community citizenship is another vital objective, involving fair dealings, community participation, maintaining attractive surroundings, and proper trash removal. Some firms extend this to providing financial, medical, and educational benefits to local residents. Additionally, businesses must support laws and regulations by paying taxes, following zoning and parking laws, and meeting government standards. Finally, protecting the quality of the environment has shifted from a discretionary choice to a mandatory requirement due to stringent worldwide laws protecting natural resources from harmful practices.
Classifications of Business Organizations
Most business activities are categorized into three broad classifications, though a single company may engage in all three. Usually, one classification constitutes the major interest of the firm. Hybrid businesses are specifically defined as those that conduct more than one type of these activities simultaneously.
Service Companies provide activities for a fee rather than dealing in tangible products. Examples include doctors, CPAs, lawyers, and engineers. In these firms, operating costs are treated as period costs, meaning they become expenses in the time period they are incurred. Net income usually differs from cash flow only due to accounts such as receivables, payables, supplies, and depreciation. Internally, these firms track revenues and expenses by procedure or client; for instance, hospitals track revenue by procedure type, while law firms trace salary costs by the time spent on specific cases.
Merchandising Companies act as intermediaries in the distribution chain, buying finished goods from other businesses to sell to others. They define these tangible products as merchandise. Merchandising is further split into two categories: Wholesale Merchandisers (e.g., Macro, Inc. and Uniwide Corp.), which buy from manufacturers and sell to other businesses, and Retail Merchandisers (e.g., Shoemart, Rustan's Department Store, and various clothing or shoe stores), which sell directly to the end consumer. For these firms, merchandise costs are considered inventoriable and product costs, while all other expenses are period costs.
Manufacturing Companies involve the conversion of raw materials into tangible physical products. This conversion typically occurs in a factory, where resources are consolidated. Examples include the San Miguel Corporation, Intel (computer components), and Purefoods Inc. Factory environments include print shops for customer requests, soft-drink bottling plants, and breakfast cereal manufacturers processing grains.
Legal Forms of Business Organization: Proprietorship
Businesses operate within a complex environment shaped by legal, political, economic, and financial forces. The legal form of organization is a primary factor in this environment. A sole proprietorship is owned by a single person who maintains complete control. From a legal standpoint, the owner and business are one entity, making the owner personally liable for all business debts. However, from an accounting perspective, the business is treated as a separate entity, and financial statements only reflect business assets and liabilities.
Key characteristics include the fact that the owner cannot receive a salary; instead, they make withdrawals which reduce owner's equity. The business itself does not pay income taxes; profits or losses are reported on the owner's personal tax return. Advantages include ease of entry and exit (no formal charter required), full ownership of profits, tax savings if individual rates are lower than corporate rates, and minimal government regulation. Disadvantages include unlimited liability (personal assets can be seized by creditors), limitations in raising capital (restricted to the owner's assets and borrowing capacity), and a lack of continuity as the business ceases upon the owner's death or retirement.
Legal Forms of Business Organization: Partnership
A partnership is a legal arrangement where two or more persons contribute capital or services and share profits and losses. A formal partnership is governed by a written partnership agreement filed with the Securities and Exchange Commission (SEC). Partners can be general (having unlimited liability and management control) or limited (liability restricted to their investment amount, but they cannot participate in management).
Advantages of partnerships include ease of formation with low start-up costs, additional sources of capital from multiple individuals, and a broader management expertise base. Like proprietorships, the partnership as an entity is not subject to income tax; income is distributed to partners who report it on their individual tax returns. Disadvantages include the unlimited liability of general partners, potential lack of continuity upon the death or withdrawal of a partner, difficulty in transferring or liquidating ownership, and limitations in raising large amounts of capital compared to corporations.
Legal Forms of Business Organization: Corporation
A corporation is an artificial being and a legal entity separate and distinct from its owners (shareholders). It can own assets and borrow money in its own name. Shareholders do not usually manage the firm directly; they elect a Board of Directors to act on the corporation's behalf. The formation process involves filing articles of incorporation with the SEC, which must include the names of incorporators, the corporate name, purpose, share capital, and authorized shares. Internal management is governed by corporate bylaws.
Advantages include limited liability, where shareholders generally only risk their investment amount (though creditors may require co-signing or governments may pierce the corporate shield for taxes). Corporations also enjoy unlimited life and ease of ownership transfer through the sale of shares. This transferability allows for a strong financial base and capital expansion through the sale of securities like bonds or ordinary shares. Disadvantages include the time and cost intensive formation process, heavy government regulation (e.g., restrictions on asset withdrawals/dividends), and the complexity of corporate income taxes.
Categories of Business Activities
Regardless of legal form, business activities are grouped into three categories: Financing, Investing, and Operating. Each is associated with specific business documents used for recording transactions.
Financing Activities involve obtaining resources from owners and return of resources to them, as well as borrowing and repaying loans. Examples include investments by owners (tracked via Bank Deposit Slips/Statements), borrowings (Promissory Notes), and payment of dividends or withdrawals (Checks/Official Receipts).
Investing Activities include the acquisition and disposal of property, plant, and equipment (PPE), other long-term assets, and debt/equity instruments not held for trading. It also covers cash advances and collections of loans (excluding financial institutions) and specific contract payments. Evidence for land or equipment purchases and sales includes Purchase Invoices, Deeds of Sale, and Official Receipts.
Operating Activities are the primary revenue-producing activities, such as delivering goods or providing services. Examples include revenue from services (Sales Invoices), sale of merchandise (Delivery Receipts), purchase of inventory (Purchase Invoices), payment of expenses like salaries or taxes (Checks/Statements of Account), and receipt of interest income (Official Receipts).
Key Business Stakeholders
A stakeholder is any person or entity with an interest in a business's economic performance. Owners seek to maximize economic value and share in profits. Managers are authorized by owners to operate the firm and are evaluated on performance; they often have profit-sharing incentive contracts. Employees depend on the business for jobs; labor unions may use high performance to argue for wage increases, while firms use poor performance to seek concessions.
Customers have an interest in continued access to products (e.g., computer hardware or airline tickets). Creditors (lenders) invest resources by extending credit and need the business to generate cash for repayment. Finally, various levels of government (city, local, national) collect taxes based on business success and worker wages, providing incentives for businesses to locate within their jurisdictions to avoid the financial burden of unemployment.
Taxation and Interest Rates in Business
The value of financial and real assets depends on the stream of after-tax cash flows they produce. In the Philippines, the Bureau of Internal Revenue (BIR) and the Bureau of Customs (BOC) collect most revenue. Taxes include income tax, transaction taxes (Estate and Donor's taxes, VAT, Excise, Tariffs, Percentage, and Local business taxes), and property taxes (Real property and Idle land taxes). The Tax Reform for Acceleration and Inclusion (TRAIN) law, effective , is a significant piece of legislation affecting tax planning regarding depreciation, business structure, and tax credits.
Interest rates represent the price of loanable funds or the price paid for the use of money. From the borrower's view, it is a premium for acquiring goods sooner; from the lender's view, it is a reward for waiting. Interest rates link the future to the present by allowing calculation of present value. Money interest consists of three components:
Pure Interest: The real price for earlier availability.
Inflationary Premium: Compensation for the expectation that the loan will be repaid with currency of less purchasing power.
Risk Premium: Compensation for the probability of default (the risk identifying the possibility that the borrower cannot repay).