What are Capital Accounts in accounting?
Reading Time: 4 minutesWhen starting a business, entrepreneurs often think of capital. Hence, capital accounts are pivotal in the process of transforming great business ideas into real-world solutions.
This article discusses capital accounts, examples of capital accounts, capital accounts on the balance sheet, uses of capital accounts, and capital accounts vs. working accounts.
Let’s get to understand capital accounts in accounting.
What are Capital Accounts?
As an entrepreneur, you require funds to give life to your excellent business idea. The fund, known as the capital, helps handle day-to-day business operations and growth. These transactions are reflected in the capital account.
Accounting 101: Is Capital a debit or credit?
Capital is credited on the balance sheet as it is a liability for the business.
Capital accounts are a general ledger that keeps track of the rights of an individual/group of individuals’ ownership of a company from one accounting period to another.
At the end of each accounting period, the net income or losses are added or subtracted, respectively, to/from the capital accounts. The owner(s) withdrawals are deducted from the capital account to get retained earnings.
To understand capital accounts better, here’s an example.
If you start a business with USD 10,000, your capital account starts with USD 10,000. If by the end of the fiscal year, the company reports a net income of USD 20,000, your capital account would increase by USD 10,000, making it a total of USD 30,000 each.
However, if there were withdrawals and expenditures worth USD 4,000, the capital account would be less USD 4,000 – which amounts to USD 26,000.
Your company’s retained earnings are the amount of money remaining in your capital accounts after paying expenses.
So,
What are the Examples?
A company’s capital account is structured based on the types of business:
- Sole proprietorship
- Partnership or LLC
- Shareholders
- A company owns another
Sole proprietorship: The sole proprietor (you) has 100% business ownership. Therefore the owner’s capital account is reported in the financial statements as “[Owner’s Name], Capital Account.”
Partnership or LLC: Members in a business partnership all have individual capital accounts based on their capital contribution at the time of joining the company. Every partner shares in the company’s income or losses as determined by an agreement or the LLC operating contract.
Shareholders: If your company goes public, members of the public can invest in the company and own available shares on offer. They receive dividends based on the number of shares they own.
For example, if the ElonDoge company offers 50,000 shares, the retained earnings are recorded in the capital accounts. Jack, who owns 1,000 shares of ElonDoge, receives 2% dividends from the Capital account.
A company owns another: If a company is a shareholder of an LLC, the capital account cannot simply be a single person’s account.
Having listed examples,
Where do they appear on the balance sheet?
On the balance sheet, the capital account is indicated by the Owner’s equity at the end of the business’s accounting period.
The owner’s equity is obtained by deducting the total liabilities from the total assets.
Equity = Assets – Liabilities
Let’s assume you own a coffee shop in Oklahoma and want to know the equity of your business.
Your balance sheet for FY 2021 reads Coffee store is valued at USD 100,000, inventory is valued at USD 50,000, and debtors owe USD 5,000.
The balance sheet also indicates that you owe a creditor $20,000, and salaries stand at $6,000.
Your equity can be calculated as follows:
Assets = 100,000 + 50,000 + 5,000 = 155,000
Liabilities = 20,000 + 6,000 = 26,000
Equity = 155,000 – 26,000 = 129,000
Your equity in the company is $129,000.
How to maintain a capital account
Maintaining an accurate capital account has perks for your business. However, how do you ensure you don’t lose track of your business transactions on your capital accounts? Here are some tips:
Detailed records of transactions: Keep detailed records of all costs and profits. These records keep track of your company’s income, expenses, and assets. Ensure to settle bills and follow up on outstanding invoices promptly.
Use accounting software: Managing your day-to-day bookkeeping needs is more convenient with accounting software. Some processes of maintaining an accurate capital account are automated and save you productive time.
Uses
A proper recording of monies in the capital accounts measures a company’s revenue and tracks each business partner’s investments.
Here are some reasons to have an up-to-date capital account.
- Loans
- Taxes
- Track contributions
Loans: Financial institutions or creditors usually ask to see your capital accounts before giving out business loans. The capital account shows personal funds invested in your business, withdrawals and the likelihood of not going bankrupt.
Taxes: It’s important to track your business’s profits and losses in the capital account. This helps you understand the amount owed in taxes and those that are deductible.
Check out the tax deduction cheat sheet for small businesses.
For big companies, taxes are paid on income owned by shareholders. The government taxes corporate income, also known as capital gains, through dividends and stock:
Track contributions: Capital accounts help you keep tabs on every investment a partner contributes to the company. This is essential because more investments would equally increase the owner’s equity interest in the company.
Are Capital accounts and Working Capital the same? Not really. Let’s look at the key differences.
Capital accounts vs. Working capital
Capital accounts are records of the owner or each owner’s (Partnership/LLC) investment in a company and the company’s net worth at a particular period. It also shows the economic benefits of the owner(s) after the net income or losses are added or subtracted, respectively.
As a business grows, each capital account grows in proportion to the partner’s initial capital investment.
Working capital represents your company’s ability to pay off liabilities with available assets. The value of working capital indicates the short-term financial health of a company, its capacity to clear its debts within a year, and operational efficiency.
Working Capital = Current Assets – Current Liabilities
Final thoughts
Keeping track of your bookkeeping processes ensures business continuity. A detailed recording of transactions in your Capital accounts helps you measure the increase/decrease in investments and interests and know your company’s financial health.
Akaunting eases the process of staying on top of your everyday business activities. Start tracking your business transactions.
