Limited Liability Company

Need for Limited Companies

Limited liability companies, more commonly referred to as limited companies, came into existence
originally because of the growth in the size of businesses, and the need to have a lot of people investing
in the business who would not be able to take part in its management.

Limited liability

The capital of a limited company is divided into shares. To become a member of a limited company, or a
shareholder, a person must buy one or more of the shares. If shareholders have paid in full for their
shares, their liability is limited to what they have already paid for those shares. If a company loses all its
assets, all those shareholders can lose is their shares. They cannot be forced to pay anything more in
respect of the company's losses. Shareholders who have only partly paid for their shares can be forced
to pay the balance owing on the shares, but nothing else. Shareholders are therefore said to have
'limited liability' and this is why companies are known as 'limited liability' or, more usually, simply
'limited' companies. By addressing the need for investors to have limited risk of financial loss, the
existence of limited liability encourages individuals to invest in these companies and makes it possible to
have both a large number of owners and a large amount of capital invested in the company.

Public and private companies.

In the UK, there are two main classes of company, the public company and the private company. Private
companies far outnumber public companies. In the Companies Act, a public company is defined as one
which fulfils the following conditions:

• Its memorandum (a document that describes the company) states that it is a public company, and that
it has registered as such.

• It has an authorised share capital of at least £50,000.

• Minimum membership is one. There is no maximum.

• Its name must end with the words 'public limited company' or the abbreviation 'PLC. It can have the
Welsh equivalent ('CCC') if registered in Wales

PLCs can, but don't have to, offer their shares for sale on the Stock Exchange. It is through the Stock
Exchange that a large ownership base can be established.

A private company is usually, but not always, a smaller business, and may be formed by one or more
persons. It is defined by the Act as a company which is not a public company. The main differences
between a private company and a public company are that a private company

• can have an authorised capital of less than £50,000; and

• cannot offer its shares for subscription to the public at large, whereas public companies can.

This means that if you were to walk into a bank, or similar public place, and see a prospectus offering
anyone the chance to take up shares in a company, then that company would be a public company, i.e. a
PLC. The shares that are dealt in on the Stock Exchange are all those of public limited companies. This
does not mean that shares of all public companies are traded on the Stock Exchange. For various
reasons, some public companies have either chosen not to, or have not been allowed to have their
shares traded there. The ones whose shares are traded are known as 'quoted companies' meaning that
their shares have prices quoted on the Stock Exchange. They have to comply with Stock Exchange
requirements in addition to those laid down by the Companies Act and accounting standards.

A limited company is said to possess a 'separate legal identity' from that of its shareholders. Put simply,
this means that a company is not seen as being exactly the same as its shareholders. For instance, a
company can sue one or more of its shareholders, and similarly, a shareholder can sue the company.
This would not be the case if the company and its shareholders were exactly the same thing, as one
cannot sue oneself. This concept is often referred to as the veil of incorporation

Prospectus.

Is a document prepared by a limited company when registering the business with the government
stating the amount of capital it is authorized to raise and the number of shares it is going to sell to the
public.

Directors of the company

The day-to-day business of a company is not carried out by the shareholders. The possession of a share
normally confers voting rights on the holder, who is then able to attend general meetings of the
company. At one of these general meetings, normally the Annual General Meeting or AGM, the
shareholders vote for directors, these being the people who will be entrusted with the running of the
business. At the Directors meeting they will elect a Managing Director or CEO to manage the day to day
operations of the company. The Managing Director will now hire departmental managers to manage the
different departments in the business.

Share capital

Shareholders of a limited company obtain their reward in the form of a share of the profits, known as a
dividend. The directors decide on the amount of profits which are placed in reserves (i.e. 'retained'). The
directors then propose the payment of a certain amount of dividend from the remaining profits. It is
important to note that the shareholders cannot propose a higher dividend for themselves than that
already proposed by the directors. They can, however, propose that a lesser dividend should be paid,
although this is very rare indeed. If the directors propose that no dividend be paid, then the
shareholders are powerless to alter the decision

From Profits

1.Companies retained / moved to reserves

2.The dividends is paid to preference shareholders

3.Then dividends is paid to ordinary shareholders

4.Then profits are retained in the business c/d

The dividend is usually expressed as a percentage. A dividend of 10 per cent in Business A on 500,000
ordinary shares of £l each will amount to £50,000. A dividend of 6 per cent in Business B on 200,000
ordinary shares of £2 each will amount to £24,000. A shareholder having 100 shares in each business
would receive £10 from Business A and £12 from Business B. There are two main types of shares:

1 Preference shares. Holders of these shares get an agreed percentage rate of dividend before the
ordinary shareholders receive anything.

-receive a fixed rate of dividend.

-not be entitled to vote in the shareholders' annual general meeting.

-receive their dividends of profit before the ordinary share dividend (higher priority).

-receive capital before ordinary shareholders in the event the company is closed down.

2 Ordinary shares. Holders of these shares receive the remainder of the total profits available for
dividends. There is no upper limit to the amounts of dividends they can receive.

-receive variable dividends each year.

-be entitled to vote in shareholders' meetings with one vote per share.

-be given their dividends of profit after the preference share dividend.

-be the last to receive their share capital if the company goes bankrupt.

The two main types of preference shares are non-cumulative preference shares and cumulative
preference shares:

1 Non-cumulative preference shares. These can receive a dividend up to an agreed percentage each
year. If the amount paid is less than the maximum agreed amount, the shortfall is lost by the
shareholder. The shortfall cannot be carried forward and paid in a future year.

2 Cumulative preference shares. These also have an agreed maximum percentage dividend. However,
any shortfall of dividend paid in a year can be carried forward. These arrears of preference dividends will
have to be paid before the ordinary shareholders receive anything
Share capital: different meanings

The term 'share capital' can have any of the following meanings:

1 Authorised share capital. Sometimes known as 'registered capital' or 'nominal capital'. This is the total
of the share capital which the company is allowed to issue to shareholders by the law. It is written down
in the Prospectus.

2 Issued share capital. This is the total of the share capital actually issued to shareholders.

If all of the Authorised share capital has been issued, then 1 and 2 above would be the same amount.

3 Called-up capital. Where only part of the amount payable on each issued share has been asked for, the
total amount asked for on all the issued shares is known as the called-up capital. Eg 80cents called up of
$1 shares.

4 Uncalled capital. This is the total amount which is to be received in future relating to issued share
capital, but which has not yet been asked for. Eg is 20 cents uncalled of $1 shares.

5 Calls in arrears. The total amount for which payment has been asked for (i.e. 'called for'), but has not
yet been paid by shareholders. Eg. A shareholder has came up short with $ 100
6 Paid-up capital. This is the total of the amount of share capital which has been paid for by

shareholders.
Uncalled Capital-$ 750,000 x 0.2 =$ 150, 000 Capital

Loan Notes- Debentures

The term loan note is used when a limited company receives money on loan, and a document called a
loan note certificate is issued to the lender. Interest will be paid to the holder, the rate of interest being
shown on the certificate. (You will sometimes see them referred to as 'debentures', 'loan stock' or 'loan
capital', but the correct term is 'loan note'.)

Interest on loan notes has to be paid whether profits are made or not, it is deducted in the Profit and
Loss from Gross Profit under expenses. However the interest on Loan Notes must be paid yearly and the
original loan repaid at a set time. They are, therefore, different from shares, where dividends depend on
profits being made. A loan note may be either:

• redeemable, i.e. repayable at or by a particular date; or Eg 2030

• irredeemable, normally repayable only when the company is officially terminated by going into
liquidation. (Also sometimes referred to as 'perpetual' loan notes.) If dates are shown on a loan note,
e.g. 2013/2020, it means that the company can redeem it in any of the years covered by the date(s)
showing, in this case 2013 to 2020 inclusive.

A debenture is a document given to someone who has loaned the company money. It states the amount
of the loan, the interest payable each year, and the date on which the loan is to be repaid.

1- Debenture holders are liabilities of the company – NOT owners as it is with shareholders.

2- The interest must be paid regardless of the profitability of the company.

3- Debentures due to be paid within a year are shown on the balance sheet as CURRENT LIABILITIES.

4- Those due to be paid in more than one year are shown as LONG TERMLIABILITIES.
5- Debenture holders have no voting rights within the company's meetings.

6- Debenture holders receive a fixed rate of interest

7- Debenture holders are repaid before any shareholders in case the company is closed down.

Interest Payable on debentures is shown as an expense in the Profit and Loss account (Income
Statement) and a Current Liability in the Balance Sheet. This is because at the end of the year when the
Balance Sheet is drawn up the interest payable to the debenture holder will not have yet been paid and
so the company is still liable in the short term.

Statements of profit or loss of companies

The trading account section of the statement of profit or loss of a limited company is no different from
that of a sole trader or a partnership. However, some differences may be found in the profit and loss
account section. Two expenses that would be found only in company accounts are directors'
remuneration and loan note interest (debenture) which are deducted as expenses in the Profit and Loss
Account.

Statement of changes in equity

Unlike partnership statements of profit or loss, following the profit and loss account section of company
there is a section called the 'profit and loss appropriation account'. Instead, companies produce a
statement of changes in equity. This shows separately: and are deducted

(a) The retained profit for the period; (Reserves, Asset replacement reserve)

(b) Distributions of equity (e.g. dividends) and contributions of equity (e.g. share issues);

(c) A reconciliation between the opening and closing carrying amount of each component of equity (i.e.
share capital and reserves).

Taxation is shown as a deduction before arriving at retained profits on the face of the statement of
profit or loss.

'Revenue reserves', which include the retained profits and the general reserve, can be treated as
available for payment of dividends.

Revenue Reserves – are created by ploughing profits back into the company

Examples: General Reserve – created for general purposes in future

Fixed Asset Reserve – created to purchase fixed assets

Revenue reserves and retained profit are recorded in the balance sheet under the heading

"Share Capital and Reserves" or “Shareholders’ Funds”.

'Capital reserves', which will include revaluation reserves on property and land, and also some reserves
(which you have not yet met) which have to be created to meet some legal statutory requirement,
cannot be treated as available for payment of dividends.
Dividends

Dividends are paid to shareholders as a way of distributing the profits of the company. Dividends are
normally expressed as “dollars per share” eg $0.10 for every share held. Directors decide if a company
will be paying out a dividend or not. They look at factors such

as:

1. the availability of profits

2. the availability of cash to pay the dividend

3. whether it would be better to keep the profits in the company to allow it to grow

4. whether the market price of the shares will be affected or not

Directors may pay out a dividend more than once per year. A dividend paid half way through the year is
called an INTERIM dividend, and at the end of the year it is called a FINAL dividend.

Dividends payable at the end of the year are entered in the Profit and Loss Appropriation Account
(Income Statement) and as a Current Liability in the Balance Sheet. This is because at the end of the year
when the Balance Sheet is drawn up the dividend payable to the shareholder will not have yet been paid
and so the company is still liable in the short term.

Retained Profit and Reserves

Retained profit - is the profit that is not appropriated (divided) for dividends or reserves and remains as
a balance on the profit and loss appropriation account and is carried forward to the next year to help
fund business plans in the future.
Fixed Asset 27 000

Current Asset 13000

Less Current Liabilities 5000

Working Capital 8000

35 000

Long Term Liabilities 8000

Share Capital 20000

Reserves 7000

35 000
Statement of Changes in Equity

Retained Profits 100 391

General Reserve 10 000

Preference Dividend 20 000

Ordinary Dividends (paid -35000) still to pay 35 000 ( 10% x 700 000=70 000 /2=35 000)

35 000

Total 65 000

Retained Profit 35 391

Fixed Asset 1 351 400

Current Asset 285 903

Less Current Liability 178 700

107 203

1 458 603

Financed by

10% Loan Notes 300 000

Share Capital 900 000

1200 000

Share Premium 100 000

General Reserve (50+10) 60 000

Retained Profits (43 2121 +35391) 78 603

238 603

1 438 603