What do you understand by a sole proprietorship firm? Explain its merits and limitations?


By Harshvardhan, the Subject Matter Expert at Edumarz

Solution: Sole proprietorship is a popular form of business organization and is the most suitable form for small businesses, especially in their initial years of operation. Sole proprietorship refers to a form of business organization that is owned, managed and controlled by an individual who is the recipient of all profits and bearer of all risks. This is evident from the term itself. The word “sole ” implies “only” and “proprietor” refers to “owner”. Hence, a sole proprietor is the one who is the only owner of a business. This form of business is particularly common in areas of personalized services such as beauty parlours, hair salons and small scale activities like running a retail shop in a locality.

A sole proprietorship offers many advantages. Some of the important ones are as follows:

(i) Quick decision making: A sole proprietor enjoys a considerable degree of freedom in making business decisions. Further, the decision making is prompt because there is no need to consult others. This may lead to timely capitalisation of market opportunities as and when they arise.

(ii) Confidentiality of information: Sole decision making authority enables the proprietor to keep all the information related to business operations confidential and maintain secrecy. A sole trader is also not bound by law to publish a firm’s accounts.

(iii) Direct incentive: A sole proprietor directly reaps the benefits of his/her efforts as he/she is the sole recipient of all the profit. The need to share profits Does not arise as he/she is the single owner. This provides the maximum incentive to the sole trader to work hard. 

(iv) Sense of accomplishment: There is a personal satisfaction involved in working for oneself. The knowledge that one is responsible for the success of the business not only contributes to self-satisfaction but also installs in the individual a sense of accomplishment and confidence in one’s abilities.

(v) Ease of formation and closure: An important merit of a sole proprietorship is the possibility of entering into business with minimal legal formalities. There is no separate law that governs sole proprietorship. As sole proprietorship is the least regulated form of business, it is easy to start and close the business as per the wish of the owner.

Notwithstanding various advantages, the sole proprietorship form of organization is not free from limitations. Some of the major limitations of a sole proprietorship are as follows:

(i) Limited resources: Resources Of A sole proprietor are limited to his/her personal savings and borrowings from others. Banks and other lending institutions may hesitate to extend a long term loan to a sole proprietor. Lack of resources is one of the major reasons why the size of the business rarely grows much and generally remains small.

(ii) Limited life of a business concern: The sole proprietorship business is owned and controlled by one person, so death, insanity, imprisonment, physical ailment or bankruptcy of a proprietor affects the business and can lead to its closure.

(iii) Unlimited liability: A major disadvantage of a sole proprietorship is that the owner has unlimited liability. If the business fails, the creditors can recover their dues not merely from the business assets, but also from the personal assets of the proprietor. A poor decision or an unfavourable circumstance can create a serious financial burden on the owner. That is why a sole proprietor is less inclined to take risks in the form of innovation or expansion. 

(iv) Limited managerial ability: The owner has to assume the responsibility of varied managerial tasks such as purchasing, selling, financing, etc. It is rare to find an individual who excels in all these areas. Thus decision making may not be balanced in all cases. Also, due to limited resources, a sole proprietor may not be able to employ and retain talented and ambitious employees.

Leave a Reply