# Firms: Definition in Business, How They Work, and Types

> **Definition**
>
> A firm is an organization that conducts business activities, such as corporations and partnerships, to make profits.

## What Is a Firm?

A firm is a for-profit business organization that provides professional services. Firms can be corporations, [limited liability companies (LLCs)](https://www.investopedia.com/terms/l/llc.asp), or partnerships. When used in a title, "firm" is typically associated with businesses that provide professional law and accounting services, but the term may be used for a wide variety of businesses, including finance, consulting, marketing, and graphic design firms, among others.

### Key Takeaways

*   A firm is a for-profit business, usually formed as a partnership that provides professional services.
*   The theory of the firm posits that firms exist to maximize profits.
*   Unlike a firm, a company is a business that sells goods and/or services for profit.
*   A firm may use natural, capital, or people-related resources to generate operational success.

![Firm](https://www.investopedia.com/thmb/36wym7reSj2z4oKGhibT1fnnuRU=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/firm.asp-FINAL-244b0e2e791345829b8a75cf06655244.png)

*— Investopedia / Jiaqi Zhou*

## Theory of the Firm

In microeconomics, the [theory of the firm](https://www.investopedia.com/terms/t/theory-firm.asp) attempts to explain why firms exist, why they operate and produce as they do, and how they are structured. The theory of the firm asserts that firms exist to maximize profits.

This theory, though, changes as the economic marketplace changes. More modern theories would distinguish between firms that work toward long-term [sustainability](https://www.investopedia.com/terms/s/sustainability.asp) and those that aim to produce high levels of profit in a short time.

## Firm vs. Company

Although they appear synonymous and are often used interchangeably, there is a difference between a firm and a company. A company can be any trade or business in which goods or services are sold to produce income. It also encompasses all business structures like a [sole proprietorship](https://www.investopedia.com/terms/s/soleproprietorship.asp), partnership, and corporation.

On the other hand, a firm typically excludes the sole proprietorship business. It generally refers to a for-profit business managed by two or more partners providing professional services, such as a law firm. In some cases, a firm can be a corporation.

> **Fast Fact**
>
> Most firms have just one location. However, a business firm consists of one or more physical establishments, which fall under the same ownership and use the same employer identification number (EIN).

## Types of Firms

A firm's business activities are typically conducted under the firm's name, but the degree of legal protection for employees or owners depends on the type of ownership structure under which the firm was created.

Some organization types, such as corporations, provide more legal protection than others. There exists the concept of the [mature firm](https://www.investopedia.com/terms/m/mature-firm.asp) that has been firmly established. Firms can assume many different types based on their ownership structures:

*   **Sole proprietorship or sole trader:** This type of firm is owned by one person who is [liable](https://www.investopedia.com/terms/l/liability.asp) for all costs and obligations. This individual owns all assets. Although not common under the firm umbrella, some sole proprietorship businesses exist that operate as firms.
*   **Partnership:** This type of firm is a business owned by two or more people. Keep in mind, that there is no limit to the number of partners that can have an ownership stake. A partnership's owners each are liable for all business obligations, and together they own everything that belongs to the business.
*   **Corporation:** In a corporation, the businesses' financials are separate from those of the owner(s), which means they are not liable for any costs, lawsuits, or other obligations of the business. A corporation may be owned by individuals or a government. Though business entities, corporations can function similarly to individuals. For example, they may take out loans, enter into contract agreements, and pay taxes. A firm that is owned by multiple people is often called a company.
*   **Financial cooperative:** Similar to a corporation, a [financial cooperative's](https://www.investopedia.com/terms/f/financial_cooperative.asp) owners have limited liability. The difference, though, is that its investors have a say in the company's operations.

> **Important**
>
> Most firms will not operate as a sole proprietorship as this means the individual is personally liable for faults of the firm.

## Resources Used by Firms

The objective of a firm to is convert inputs into outputs. For this reason, firms use a variety of resources to generate products, services, and offerings to clients. These resources may include but aren't limited to:

*   **Natural resources:** If a firm sells products, it often utilizes [natural resources](https://www.investopedia.com/articles/markets-economy/090516/10-countries-most-natural-resources.asp) to build the goods and inventory to eventually convert to a finished product. These resources may be directly sourced, though may also be acquired from a [third party](https://www.investopedia.com/terms/t/third-party.asp).
*   **Capital resources:** Firms often need upfront investment to buy the required equipment and space needed to function. There may also be ongoing [capital](https://www.investopedia.com/terms/c/capital.asp) needs before the firm becomes self-sustaining. These capital resources may be from external investors, though the long-term goal is to have these capital resources be generated by firm operations.
*   **Human resources:** The employees of a firm are the lynchpin that ensures the underlying business can operate. People's time, expertise, and networks are all resources that go into a firm to further enhance market offerings. Human resources often reference a specific department, but people resources exist throughout a company in all departments.
*   **Entrepreneurship:** [Entrepreneurship](https://www.investopedia.com/articles/personal-finance/101414/why-entrepreneurs-are-important-economy.asp) is the utilization of knowledge, expertise, and business sense to translate an idea into a financially successful operation. This includes using business, legal, and entrepreneurial resources to successfully bring a product to market and ensure the offering is well-received by markets.

## Activities of a Firm

The activities of a firm can often be broken down into three categories: business operating activities, investing activities, and financing activities. These three categories are listed on a firm's statement of cash flow and are discussed further below.

### Business Operating Activities

The primary activity of a company (and the primary section on a [statement of cash flow](https://www.investopedia.com/investing/what-is-a-cash-flow-statement/)) is the operating activities section. This section ties to the actual core business of the company. These activities include selling products or incurring business expenses. Most of these activities are related to the [income statement](https://www.investopedia.com/terms/i/incomestatement.asp), as these activities most often relate to a company's day-to-day operations and income.

In some cases, the operating activities section of a statement of cash flow is negative. If the amount is negative, that means the company is using/spending more cash than it is bringing in specific to business operations. This also means the company must rely on the other two sections to ensure enough cash flow is coming into the company to maintain operations.

### Investing Activities

[Investing activities](https://www.investopedia.com/articles/financial-theory/11/cash-flow-from-investing.asp) are the long-term cashflow activities a company incurs to plan for the future and ensure it has the infrastructure to scale operations. Examples of investing activities include acquiring equipment, constructing office buildings, or buying heavy equipment.

Although these activities may not be required for day-to-day operations, investing activities play an integral part in a firm's long-term success. Consider a firm that makes its own goods. By investing in a corporate warehouse and robust manufacturing plant, the firm is more likely to achieve business operation success.

### Financing Activities

The last section of activities of a firm are the [financing activities](https://www.investopedia.com/terms/c/cashflowfromfinancing.asp). Although these are also not usually part of the day-to-day operations of a firm, the financing activities play an important in ensuring the long-term financial health of a firm.

Some financing activities are cash inflows, while other are cash outflows. For example, firms may decide to award dividends to investors funded from net income of the firm. Alternatively, firms may borrow money from lenders or issue equity to investors to raise capital to support the day-to-day operations.

## Why Is a Business Sometimes Called a Firm?

The word firm has Latin roots to the word signature, which indicates that it may have historically been used to describe the name of a company. In addition, the etymology of the word translates back to "a business" or "a name of a business".

## What Are the 4 Types of Firms?

A firm may take a variety of legal structures, including sole proprietorships, partnerships, corporations, or cooperatives. The rules dictating the operations and organizational structure of the company are often heavily dictated by the legal type of the firm.

## What Is the Purpose of a Firm?

Though an oversimplification, the purpose of a firm is to make money. A nonprofit is often not referred to as a firm; therefore, a firm's purpose is to facilitate trade between a manufacturer or retailer with a client. A firm's purpose is to ensure a good or service is transmit to those who need it with the expectation that the firm can generate a profit along the way.

## The Bottom Line

A firm often refers to a company that sells a service to customers, though sometimes a physical good may be transmitted as well. The ultimate goal of a firm is to make money, as a firm is often not a non-profit. The activities of a firm can usually be broken into the operating, investing, and financing aspects of the firm.

> **Article Sources**
>
> 1.  U.S. Small Business Administration. "[Choose a Business Structure](https://www.sba.gov/business-guide/launch-your-business/choose-business-structure)."
>     
> 2.  Hart, Oliver. "[Thinking about the Firm: A Review of Daniel Spulber’s The Theory of the Firm](https://scholar.harvard.edu/sites/scholar.harvard.edu/files/hart/files/reviewofspulberstheory-firm.pdf)." _Journal of Economic Literature_, vol. 49, no. 1, March 2011, pp. 109.
>     
> 3.  Online Etymology Dictionary. "[Firm](https://www.etymonline.com/word/firm)."