Partnerships (Cambridge (CIE) O Level Accounting)

Partnerships

What is a partnership?

• A partnership is a business in which two or more people operate as owners with the main purpose of making profits

• Normally a partnership consists of two to twenty partners 

• Sometimes a partnership is formed when a sole trader wishes to expand or grow their business

• Two or more sole traders may decide to combine together their resources such as money and assets to form a new business

What are the advantages of operating as a partnership?

• Forming a partnership is relatively easy as formal permission is not required to set it up

• Partners have access to additional finance because all partners contribute to raising the capital of the business

• Partners have access to each other's skills and expertise

  • For example, a makeup artist might partner up with a hairstylist

• Partners share the risks of operating the business

• Partners can cover each other for sickness and holidays 

What are the disadvantages of operating as a partnership?

• Profits are shared among all partners

  • Unlike a sole trader who keeps all the profits, partners will share it  

• Partners may find that they have disagreements 

• Partners may take longer to come to decisions about the operating activities of the business due to them having different opinions

• All partners are responsible for the debts of the business

  • Even if the debt was only created by one of the partners

Partnership Agreement

What is a partnership agreement?

• A partnership agreement is a document that sets out the terms of how the partnership should operate

• Its purpose is to help partners avoid disagreements in the future

What is contained in the partnership agreement?

• The agreement contains information about:

  • The amount of capital each partner is to invest

  • Whether or not the partners are entitled to interest on their capital 

    • And if so, the percentage to be paid

    • Interest on capital is given to reward partners for investing their money into the business

  • Whether or not salaries are paid to each partner

    • And the amount to be paid

  • Whether or not partners are entitled to drawings and the limit each partner can take out of the business

  • Whether or not interest is charged on partners' drawings

    • And if so, the percentage to be charged

    • Interest on drawings is charged to discourage partners from withdrawing money from the business

  • Whether or not the partners are entitled to interest when they loan their own money to the business

    • And if so, the percentage to be paid

    • Interest on loans is given to reward partners for loaning their money to the business

  • The distribution of profits and losses to be shared between partners

• Interest and salaries do not involve physical money

  • The amounts are added to the balances that the business owes the partners

  • The partners can choose to withdraw these amounts as drawings