In the realm of business, having an understanding of different entities is significant. When you want to establish your company, you can go for limited liability companies, partnerships, or firms. It all comes down to your needs.
However, firms are a more common business setup. In this blog, we will explore what is a firm in business, its different types, real-world examples, and much more to help you understand its operations.
30-Second Summary
If you wonder what a firm is in business, you are not alone. Starting a firm can be a dream for many. But many people are not aware of its functions, types, and characteristics.
This blog will explore these aspects of firms in detail and more. Keep reading to explore the theory and purpose of firms, their role in the economy, and how you can start your own firm.
Definition of Firm in Business
A firm is a for-profit organization. It provides professional services. Most often, this term is associated with accounting and legal corporations.
However, “firm” can be used for various businesses, such as marketing, finance, consulting, and graphic design. A firm uses capital, natural, or people-related resources to achieve operational success.
Theory of the Firm
Microeconomics explains what is a firm in business, detailing its purpose, its structure, and how it operates. According to this theory, firms exist to maximize profit. This theory changes with the changes in economic marketplaces.
Modern theories now focus on explaining the long-term sustainability of firms and how to maximize profit in a short amount of time.
Purpose of a Firm in Business
In terms of business, the purpose of a firm is to create value for its stakeholders. It includes shareholders, customers, employees, and the community.
Firms create this value by producing services and goods that fit the preferences of customers, generating profits for shareholders, and providing employment opportunities.
This approach has an impact on the overall economic development of a society. In short, the purpose of a firm in business is to create value while operating legally and ethically.
Characteristics of a Firm
To fully understand what a firm is in business, you need to learn about its distinct characteristics.
Ownership: It can be owned by a single person or multiple individuals.
Liability: Based on the legal structure, owners may have limited or unlimited liability.
Leadership: Firms have managers or leaders who run them.
Capital and Profits: The capital of the firms comes from other parties and owners. The losses and profits are divided according to the agreement.
Types of Firms
The firm structure and ownership are two factors that determine the types of this business entity.
Traditional Types
Below are the traditional types of firms.
Sole Proprietorship
This firm is owned by only one person. That owner is liable for all obligations and costs. Moreover, that person owns all the assets as well. This type of business is not common under the firm umbrella; however, some sole proprietorship businesses do exist as firms.
Partnership
This firm is owned by two or more individuals. In a partnership, every business member is liable for the company’s obligations. Moreover, all members own everything that belongs to the business.
Corporation
The financial statements of the companies are separate from the owners. Corporations can be owned by the government or individuals. A corporation can function similarly to an individual. It can take out loans and pay taxes.
Financial Cooperative
In a financial cooperative firm, the liability of the owners is limited. However, they still have a say in the company’s operations.
Modern Variations
Let’s see what the modern types of firms are.
LLC (Limited Liability Company)
It is a hybrid business structure. This firm merges the liability protection of corporations with the tax advantages of sole proprietorships or partnerships. The owners of such firms are called members.
The management is flexible. The personal assets of members are protected from lawsuits and business debts.
LLP (Limited Liability Partnership)
In this type of firm, all or some business members have limited personal liability for the partnership’s debt. The individual partners are protected from liabilities caused by the misconduct or negligence of the other partner.
This is a common firm type in professional services, such as consulting, law, and accounting.
PLLC (Professional Limited Liability Company)
This LLC is designed specifically for professionals, such as doctors, architects, accountants, and lawyers. This firm is only available to people active in regulated professions.
It provides the same liability as an LLC. However, it does not protect a professional from liability for their own malpractice.
LLLP (Limited Liability Limited Partnership)
This firm is a variation of an LP (limited partnership). In this structure, even the general partners have limited liability. It is designed to protect all partners from business debts.
This firm has flexible profit distribution and pass-through taxation, similar to a limited partnership business.
Firm vs Company: A Comparison
While company and firm are used synonymously, they are both different business entities. They both engage in commercial activities.
However, a company is a legally registered and incorporated business. On the other hand, a firm is a broader term, encompassing different types of organizations.
We learned what is a firm in business. Let’s see how it differs from a company.
| Aspects | Company | Firm |
| Meaning | A legal entity formed under the laws of a particular jurisdiction | A broad term for an economic entity, including corporations and partnerships |
| Purpose | To engage in commercial activities, conduct business operations, and generate profit | To maximize profit |
| Legal Structure | Legal incorporation and adherence to corporate law | Sometimes unregistered and unofficial, often used for professional partnerships |
| Type | Can be a private limited company, a public limited company, or other types recognized by law | Includes various types of business entities, including sole proprietorship, corporations, and partnerships |
| Ownership and Management | Owned by its shareholders and managed by its board of directors and officers | Ownership and management depend on the structure of, e.g, a single owner (sole proprietorship) or a board of directors (corporation) |
| Operations | Operates in various industries and sectors, and has a broad variety of products, services, and activities | Operates in different sectors and industries, and encompasses various business operations and activities |
| Legal Recognition | A legally recognized entity with specific rights, liabilities, and obligations under the law. | May have legal recognition if structured. However, the term is often used informally to describe any business regardless of its legal form. |
| Example | Apple Inc. | McKinsey & Company |
Economic Role of Firms
Firms play a fundamental role in the circular income within an economy. They produce goods and services, offer job opportunities, and generate tax that helps the public.
Employment Creation: The majority of the jobs in the economy are offered by small, medium, and large firms. Furthermore, in the U.S., small businesses make up 99.9% of all firms.
Innovation Drivers: Many startups and corporations are at the forefront of introducing new technology. Many cutting-edge innovations come from small firms.
GDP Contributors: Firms are the central source of GDP through trade and production. For example, in the U.S., 43.5% GDP is associated with small firms, which shows their economic significance.
Global Competitiveness: Multinational firms are the reason for technology transfer, foreign investment, and market expansion. Export-oriented firms make the entire economy of a country strong.
Resources Used by Firms
The goal of a firm is to convert the input into outputs. For this reason, it uses multiple resources to provide different products and services to clients.
Have a look at some of the resources used by firms.
Natural Resources: A firm that sells goods uses natural resources. These resources are sourced directly or can be acquired from a third party.
Capital Resources: These resources are used as an upfront investment to buy the required equipment. Initially, firms take these resources from external investors. However, the main goal is to generate capital through the firm’s operations.
Human Resources: People are the cornerstone of the company, ensuring smooth operations of the business. Their skills, time, and expertise are all resources that enhance the functions of a firm.
Activities of a Firm
The activities of a firm are divided into three categories: business operation activities, investing activities, and financial activities. These activities show where the money goes and where it comes from.
Business owners, creditors, and investors can get an idea about the financial health of a firm through these activities. Below is a detailed breakdown of these categories.
Business Operations
The main activity of the firm, which is also a primary part of the cash flow statement, is the operating activities section.
This statement shows money coming in and going out from the company’s main business, such as selling products, paying suppliers, or covering everyday expenses.
If it shows a negative amount, it means that the company is spending more than it earns. In such a case, a firm has to rely on the other two activities to ensure a stable cash flow.
Investing Activities
Investing activities are a long-term cash flow plan by a company. These activities ensure that the company is prepared for the future and has enough infrastructure to scale.
Investing activities can look like buying heavy equipment, constructing new office buildings, and purchasing land or factories.
These activities are not necessary for day-to-day operations, but it is important for a firm’s stability and long-term success.
Financial Activities
These activities are also not important for day-to-day operations. However, these are required to ensure the financial health of a firm.
Financial activities are of two types: cash inflows and cash outflows. For instance, a firm decides to award dividends to the investors that come from the net income of the company.
On the other hand, it can borrow money from lenders and issue equity to investors to raise capital to afford day-to-day operations.
Firms Around the World
Let’s see the global legal forms of firms in this section.
| Legal Form | Country or Region | Equivalent Structure | Liability Rules | Shareholder or Owner Requirements |
| S.A. (Société Anonyme) | France, Spain, Switzerland and others | Public Limited Company | Shareholders’ liability is limited to capital invested | Minimum 2 shareholders. Capital requirements vary by country |
| GmbH (Gesellschaft mit beschränkter Haftung) | Germany, Austria, Switzerland | Private Limited Liability Company | Liability limited to company assets | Usually 1+ shareholders. Minimum share capital required |
| PLLC (Professional Limited Liability Company) | United States | Limited Liability Company for licensed professionals | Liability protection for owners except for professional malpractice | Owners must hold relevant professional licenses |
| LLP (Limited Liability Partnership) | U.S., U.K., India, and others | Partnership with liability limits | Partners not liable for other partners’ negligence | At least 2 partners. No share capital requirement |
| Pty Ltd (Proprietary Limited) | Australia and South Africa | Private Limited Company | Liability limited to unpaid share capital | Limited to 50 non-employee shareholders |
| BV (Besloten Vennootschap) | Netherlands and Belgium | Private Limited Company | Liability limited to company assets | Minimum 1 shareholder. Flexible share capital rules |
How to Start a Firm
Now that you know what a firm is in business, it is time to see how you can start a firm of your own.
Idea and Plan: To begin, you need to decide on the business idea. After that, you need to create a comprehensive plan defining your goals, market analysis, and finances.
Business Structure: Do thorough research and select the legal business structure that suits your liability preferences and growth plans.
Registration: You need to register your business with the relevant authorities and get permits and licenses.
Funding: Save the initial investment through savings, loans, and investors. Outline startup costs and working capital.
Location and Setup: You need a location to set up your business. The location can be physical or virtual.
Bank Account: Open a separate bank account that is solely dedicated to managing the funds of the company.
Launch and Promote: Create a marketing strategy to promote your business and attract your prospective customers.
Examples of Firms
Have a look at different categories of firms along with their real-world examples.
Professional Services Firms Examples
These firms provide specialized expertise instead of physical goods. The legal structure of these firms is partnerships, LLPs, and PLLPs.
Some common types are:
Law firms: Baker McKenzie, Slate, Meagher and Flom LLP, and Skadden
Accounting firms: the Big Four: PwC, KPMG, Deloitte, and Ernst & Young
Consulting firms: Boston Consulting Group and McKinsey & Company
Business Firm Examples
Not every firm is a global giant. Some are family or privately owned businesses that become influential firms for the economy.
Retail and E-commerce: IKEA (foundation-owned) and Walmart (family-owned)
Technology and Electronics: Dell Technologies (privately owned) and Samsung Group (family conglomerate)
Corporate Firm Examples
These firms are legally incorporated with limited liability for shareholders. Let’s look at some of the examples.
LLCs (U.S.): Microsoft LLC Services
S.A. (Société Anonyme): France, Switzerland, Spain; Nestlé, Banco Santander, and L’Oréal
PLC (Public Limited Company): UK; Unilever PLC and Vodafone Group PLC
Pros and Cons of Firms
Firms have both positive and negative aspects.
Pros
- Firms are easier to manage compared to larger businesses.
- The decision-making process is faster in small firms.
- Some legal structures allow the profit to be shared according to each member’s contribution.
Cons
- Owners can face unlimited liability for the debts and obligations of the firm.
- Oftentimes, firms have limited funds as they rely on contributions from owners and third parties.
- Small firms struggle to obtain financing from banks and other financial institutions.
What is a Firm in Business Accounting?
In accounting, the term “firm” has a slightly different meaning. A firm in accounting operates under a single Employer Identification Number (EIN). It may consist of departments, subsidiaries, and divisions that create a consolidated financial statement.
Differences from other Definitions
Legal definition of firm: It focuses on the registration, structure, and ownership under the law.
Economic definition of a firm: It puts emphasis on the firm as a production unit in the economy.
Accounting definition of a firm: It focuses on how the firm is reported financially. Its income, liabilities, assets, and expenses are recorded under a single framework.
Example
Legal view: Apple Inc. is registered in California.
Economic view: Apple produces physical goods, such as iPhones, and services, such as Apple Music, to generate profits.
Accounting view: Apple’s global divisions report collects results under one EIN for the financial statement.
Wrapping It Up
Firms are versatile business entities. They all have different structures, purposes, and legal treatment. From sole proprietorships to global corporations, firms strengthen economies.
In this blog, we discussed what is a firm in business, its characteristics, and types. Moreover, we explored the pros and cons of firms, their role in the accounting business, and more.
To stay updated on all business-related information, feel free to explore the Modern Business Guide.
FAQs
What is a Firm in Business?
A firm in business is an organization that is engaged in industrial, commercial, and professional activities. These activities include selling products or services to generate and maximize profits.
Is Firm and Company the same?
Not always. A company is a legally recognized organization with a specific structure. On the other hand, a firm is a broader term, often used informally to describe various types of businesses.
What are the Four Main Types of Firms?
The four main types of firms are sole proprietorships, partnerships, corporations, and cooperatives.
Can a Firm be a Nonprofit?
Yes, a nonprofit firm focuses on fulfilling a mission rather than earning profits. However, it still generates revenue to support its activities.
Can a Firm operate without being registered as a Company?
Yes, some sole proprietorships and partnerships can operate without formal registration. However, it depends on the local laws.
