Partnerships in Business: Types, Agreements, and Profit Sharing

Partnerships

A partnership is a business venture entered into by two or more individuals who share profits and losses. There are several types of partnerships, each with its own characteristics and responsibilities. Some common types are:

General Partnerships

This type of partnership involves two or more people who agree to contribute money, property, labor, or skill to carry out one or more businesses for shared profit. In this arrangement, all partners have equal rights and obligations, and they also have unlimited liability for business debts—they may be held personally responsible for paying off the entire debt if the partnership's assets aren't sufficient.

Limited Liability Partnerships (LLP)

In an LLP, the partners have limited liability, meaning their personal assets cannot be used to pay the company's liabilities and debts beyond what they invested in the company. This form of partnership provides a balance between the protection of personal assets offered under corporate structures while offering the flexibility and tax benefits of partnerships.

Limited Partnerships

Here, there are general partners who run the business and take full responsibility, and limited partners who invest capital but do not participate in running the business and enjoy limited liability. The main difference from other forms lies in the nature of the involvement of one or more partners, who can be involved only passively.

Joint Venture

This is an agreement where parties agree to pool resources to complete a specific project or transaction solely for the purpose of that project or transaction. Once completed, the joint venture entity terminates.

Partnership Agreements

Partners often enter into written contracts called partnership agreements to outline their roles, contributions, rights to profits, distribution of income, and division of responsibilities and duties before starting up a new business. These agreements help minimize potential conflicts among partners and protect their interests in case of dissolution.

Key elements of such agreements typically include:

• Profit Allocation: How profits will be distributed among partners
• Decision Making Authority: Who has the power to make certain decisions
• Buyout Rights: If a partner wants to leave, how their interest in the partnership will be bought out or transferred
• Dispute Resolution: Procedures for resolving disagreements between partners
• Termination: Conditions for ending the partnership

Profit Sharing Ratios

Partnerships usually operate on the principle of mutuality of interests, which means that they work together on equal terms for mutual advantage. However, despite operating as partners, their individual investments, contributions, or activities might differ significantly. Therefore, it becomes essential to calculate profit sharing ratios to ensure fairness and avoid disputes.

These ratios represent each partner's proportionate contribution towards the net profit earned by the firm. They are based on factors like the initial investment made, the nature of services rendered, experience, and sometimes even family ties. Common methods used to determine these ratios include:

• Percentage Method: Here, partners decide upon a percentage allocation of profit amongst themselves so that the total adds upto 100%.
• Capital Method: This method allocates profits based on the capital contributed by each partner.
• Labor Method: Here, profits are divided according to the efforts put in by each partner.

Partnership Final Accounts

Preparing partnership final accounts involves recording the transactions that took place during the accounting period, ensuring compliance with legal requirements and maintaining clear records for both internal and external purposes. Key aspects of preparing these accounts include:

• Capturing all transactions
• Classifying them into debit and credit heads
• Recording payments received and expenses incurred
• Reconciling bank statements
• Completing Trial Balance Sheet
• Preparing Profit & Loss Statement and Balance Sheet
• Closing down temporary accounts
• Carrying forward any unclosed balances

Goodwill Treatment

Goodwill is an intangible asset representing the value of a company’s brand name, reputation, customer loyalty, etc., over and above the book value of tangible assets. In a partnership context, goodwill arises when purchasing a controlling stake in another business or when acquiring other companies. It is treated differently in different jurisdictions, with some countries allowing amortization and others prohibiting it. Additionally, goodwill valuation techniques vary; however, most consider replacement cost, going concern value, and discounted cash flow models.