What is a Firm?

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Definition:

A firm is any business entity that sells a good or service to make a profit.

🤔 Understanding firms

Any business entity that operates on a for-profit basis can be considered a firm. The term can describe different business structures, including sole proprietorships and corporations. A firm can be a company such as a consumer goods store that offers a physical product. It can also describe service providers such as barbers. Though the word firm can refer to any for-profit business, we use it more often to describe entities in particular industries such as law and accounting. Many use the terms “firm” and “company” interchangeably. In the United States, both are synonyms for the term “business,” as defined by the Internal Revenue Service (aka IRS).

Example

One of the most common uses for the term firm is in the legal industry. Suppose you recently graduated from law school and moved back to your hometown to open a private practice. Your business would be considered a law firm. Many use the term firm only to describe service-providing entities such as this one, but it can also describe other types of companies.

Takeaway

A firm is like an app on your phone…

Each app on your phone has a particular purpose. Each one comes with a function that solves a specific problem in your life, even if it’s just a game that’s solving the problem of boredom! Similarly, the purpose of the firm is to provide a particular good or service to consumers, whether it be legal advice or a tasty sandwich.

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What is a firm?

A firm is a business organization that seeks to make a profit through the sale of goods and services. The term firm is synonymous with business or company. Firms can operate under several different structures, including sole proprietorships and corporations.

What is the purpose of a firm?

Different firms have different goals. Ultimately, the main purpose of most firms is to earn a profit. Otherwise, it’s not likely they’ll be able to stay in business for long.

But outside of profit maximization, firms have other purposes as well. If you talk to many business owners, they might tell you that the reason they started their business didn’t have to do with making money. They could have done that as an employee, and probably with less stress.

Instead, many people start businesses to fill a need for their customers. Consider restaurants, for example. Most people don’t open restaurants to get rich — They open restaurants to serve people delicious food.

Many firms also serve a larger purpose in their community or society. Some firms practice corporate social responsibility, which is when they seek to have a positive impact on society.

As an example, consider the shoe brand TOMS. TOMS wants to make a profit so they can pay their owners and employees, but they also have a broader societal purpose. TOMS initially promised customers that for every pair of shoes someone purchased, they would donate a pair of shoes to someone in need. Now, they focus on giving away at least one-third of their profits so they can have an impact in even more areas.

What are the different types of firms?

A firm can be an organization that provides goods or services to make a profit. But the IRS doesn’t have a legal classification for the term firm. Instead, it classifies firms according to the business structure under which they are organized. There are four primary types of firms.

Sole proprietorship

A sole proprietorship is a small business run by one person. Anyone who engages in business activities without registering as any other business structure is automatically a sole proprietor.

It’s the simplest business entity; after all, in this case, there’s no legal difference between the business and the business owner. The two share both assets and liabilities. For some people, this is good news, because it means the barrier to entry is relatively low. But this setup can also be problematic because the business owner is liable for any business debts. So if someone sues the company, they’re really suing the business owner.

Sole proprietorships are also simple in terms of paying taxes. Because your business isn’t a separate entity from you as a person, you simply claim your business’s income as your personal income.

Limited liability company

A limited liability company (LLC) is one step above a sole proprietorship. In many ways, the two are identical. For example, both are the same for tax purposes. If you’re the sole owner of an LLC, the profits and losses of your firm pass through to you.

A critical difference between a sole proprietorship and an LLC is that LLC owners have legal separation from their businesses. As a result, the business owner is not responsible for any debts or liabilities of the company. This structure offers a bit more protection to the owner.

Forming an LLC happens at the state level by filing the necessary paperwork with the appropriate state agency. Often this is done every year or every set number of years.

Partnership

Another type of firm is a partnership. When you form a business with two or more owners, you create a partnership. Two primary types of partnerships are: limited liability partnerships and limited partnerships.

A limited liability partnership works just like any other LLC. Each owner is legally separate from the business, meaning they aren’t responsible for the business’s liabilities. Similarly, each partner is distinct from the others — They aren’t accountable for the obligations of their co-owners.

A limited partnership is one where one partner doesn’t have limited liability, but the others do. If someone were to sue the firm, the partner without limited liability would be responsible for the debts of the business, but any other owners wouldn’t be. This structure is most common when there is one person with primary ownership and decision-making power over the company.

Partnerships might make sense for two or more people who want to go into business together, but who don’t want to form a corporation. Like sole proprietorships and LLCs, the money you make in a partnership is your personal income for tax purposes.

C Corporation

C corporations — often simply referred to as corporations — are public companies that are legally separate from their owners in a way that is different from any other type of firm.

In the cases of LLCs and limited liability partnerships, owners are separate for the purposes of liabilities, but not for profits and losses. In the case of a corporation, the firm is its own separate legal entity altogether.

First of all, corporations can sell company stock in the stock market. When someone buys stock in the company, they become one of the company’s owners (aka a shareholder). Corporations often have many owners.

Corporations also pay taxes differently than other types of firms. For other business structures, the owner can treat the business income as personal income for income taxes. They only pay taxes on the money once.

A corporation, on the other hand, must pay taxes on its profits before it can distribute them to the owners. Suppose a corporation makes $500,000 in profit in 2020. It’ll have to pay the current corporate tax rate of 21% on those earnings, leaving it with $395,000 after taxes. Then the corporation can distribute that money to the company’s owners. Each owner will pay taxes on any earnings they get from the corporation.

Some corporations, if they meet specific requirements, might choose to operate as S corporations. This setup allows them to avoid double taxation. Rather than paying corporate taxes, the owners of the corporation pay taxes on the company’s profits through personal income taxes.

How do firms work?

Firms work differently depending on several different factors, including what business structure they choose. If a firm decides to operate as a sole proprietorship, it’s pretty easy to get started. For a corporation, on the other hand, there’s a much more complicated process.

How a firm works also depends on the good or service they provide. Many operate as brick and mortar businesses, meaning they have a physical location (or multiple physical locations). Other firms, on the other hand, choose to operate online.

What is the difference between a firm and a company?

A company is generally defined as an entity that engages in business. “Firm” and “company” are terms that you can use interchangeably.

Colloquially, people tend to use the term company more broadly, whereas they’re more likely to use the term firm in reference to a service-based business such as a law firm or an accounting firm.

Neither firm nor company is a legal term for any kind of business organization. Instead, both terms are synonyms for the IRS legal terms of trade or business. According to the IRS, a trade or business is any activity to sell a good or service for profit.

What is the difference between a firm and an enterprise?

The term enterprise is synonymous with both firm and company. The difference is the way people most often use them. Usually, people use the term enterprise to describe entrepreneurial ventures. Rather than referring to a large franchise, it’s more likely to refer to an entrepreneur forming his or her own startup.

What is the difference between a firm and an industry?

The term industry refers to a particular sector within the economy that’s separate from others. We classify industries based on the goods or professional services they offer.

In most cases, each industry is clearly distinct from the next. For example, the restaurant industry is a single sector within the economy. Convenience stores also make up an individual industry.

A firm, on the other hand, refers to a single business organization within an industry. Each industry consists of many different firms. Let’s go back to our example of the restaurant industry. A particular city has just one restaurant industry but might have hundreds of firms within it.

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