Limited companies Revision Notes

A limited company is a business entity separate from its owners (shareholders), offering limited liability protection. This means shareholders risk only the amount they invested; their personal assets are not at risk if the company fails.

Advantages include: limited liability protecting personal wealth, ability to raise capital by issuing shares, perpetual existence unaffected by changes in ownership, and often greater credibility with suppliers and lenders.

Disadvantages include: more complex and costly to set up and run than sole traders or partnerships, legal requirements for financial reporting and disclosure, and potential loss of control if many shareholders exist. For example, a small business owner may prefer a limited company to protect personal assets but must accept increased administrative duties.

• Limited liability limits shareholder risk to invested capital.
• Separate legal identity allows the company to own assets and enter contracts.
• Raising capital through shares can fund expansion.
• More regulatory compliance and public disclosure required.
• Control may dilute with many shareholders.

Limited liability means shareholders are only liable for the company's debts up to the amount unpaid on their shares. If shares are fully paid, shareholders have no further financial obligation.

Equity represents the ownership interest in the company. It includes share capital (money raised from shareholders) and reserves (accumulated profits retained in the business). Equity is shown on the statement of financial position and reflects the residual interest after liabilities are deducted from assets.

For example, if a company has assets worth £500,000 and liabilities of £300,000, equity is £200,000. This equity belongs to the shareholders and can be split into share capital and reserves.

• Limited liability protects shareholders beyond unpaid share capital.
• Equity = Assets − Liabilities; represents owners' interest.
• Equity components include share capital and reserves.

The capital structure of a limited company consists of:

Preference share capital: shares with fixed dividends paid before ordinary shareholders, often without voting rights.

Ordinary share capital: shares representing ownership with voting rights and dividends paid after preference shares, variable in amount depending on profits and company policy.  - General reserves: profits set aside for future use, not distributed as dividends, strengthening financial stability.  - Retained earnings: accumulated net profits kept in the business after dividends are paid, part of reserves but tracked separately for clarity.  Understanding these components helps assess the company's financial health and dividend policy.

• Preference shares have priority for dividends but usually no voting rights.
• Ordinary shares carry voting rights and variable dividends.
• Reserves include general reserves and retained earnings from profits.
• Capital structure reflects funding sources and shareholder rights.

Issued share capital is the total nominal value of shares the company has offered to shareholders.

Called-up share capital is the portion of issued shares for which the company has requested payment from shareholders.

Paid-up share capital is the amount shareholders have actually paid to the company. There can be a difference if some shares are partly paid or unpaid.  For example, if a company issues 10,000 shares of £1 each, the issued share capital is £10,000. If the company calls up £0.75 per share, the called-up capital is £7,500. If shareholders have paid £7,000, the paid-up capital is £7,000, with £500 still unpaid (called but not paid). Understanding these distinctions is important for accurate financial reporting and assessing shareholder obligations.

• Issued capital = total shares offered × nominal value.
• Called-up capital = amount requested from shareholders.
• Paid-up capital = amount actually received by the company.
• Differences arise with partly paid shares.

Share capital represents ownership in the company and includes preference and ordinary shares. Shareholders have voting rights (except usually preference shareholders) and may receive dividends.

Loan capital, such as debentures, is borrowed money the company must repay with interest. Debenture holders are creditors, not owners, and have priority over shareholders if the company is wound up.

For example, a company may issue £50,000 in ordinary shares and borrow £30,000 through debentures. Shareholders share profits and risks, while debenture holders receive fixed interest regardless of profit and have no voting rights. This distinction affects financial risk and control.

• Share capital = ownership; loan capital = debt.
• Shareholders have voting rights; debenture holders do not.
• Debentures must be repaid with interest; shares may pay dividends.
• Debenture holders have priority in insolvency.

Key financial statements include: income statement (profit and loss account), statement of changes in equity, and statement of financial position (balance sheet).

The income statement shows revenue, expenses, and profit or loss for the period.

The statement of changes in equity reconciles opening and closing equity, showing movements in share capital, reserves, and retained earnings, including dividends and profits retained in the business.  The statement of financial position presents assets, liabilities, and equity at a specific date, reflecting the company’s financial position.  Adjustments may be needed for accruals, prepayments, depreciation, and other items as outlined for sole traders, adapted for limited companies. For example, if a company has accrued expenses of £1,000 at year-end, this must be added to expenses and liabilities to reflect true profit and financial position. Accurate preparation and adjustment ensure compliance and provide reliable information for decision-making.

• Income statement reports profit or loss.
• Statement of changes in equity tracks movements in share capital and reserves.
• Statement of financial position shows assets, liabilities, and equity.
• Adjustments include accruals, prepayments, and depreciation.
• Accurate statements reflect true financial health.