Capital is the overall financial resource that is invested by business owners either in the form of assets or money. It is used to conduct business operations and generate revenue. A capital account in a business is also meant to measure the ownership rights of all business owners.
Capital in accounting reflects the net worth of a business at a specific time and this general ledger account appears on the entity’s balance sheet.
What is Capital in Accounting?
Capital in accounting is a financial account that gauges the contributions made by a business owner in the form of either assets or money. It is also referred to as owner’s equity and tracks how each partner economically benefits a particular business.
As a business flourishes with time, its capital account will also grow proportionally. In case a business dissolves, this capital account will show the amount that each business partner must receive after paying off debts and liabilities.
The capital account of an entrepreneur is categorised based on the type of business one invests in. This account can be created using either a spreadsheet or accounting software.
How Does a Capital Account Work?
- All contributions from the owners’ part are credited to their capital account. The contributions can be the initial ones that were made during the establishment of the firm. It even records the contributions made later as per business requirements.
- Capital accounts are adjusted as per the profit and loss ratio after every fiscal year ends.
Types of Capital Accounts
As its name suggests, sole proprietors are referred to individuals who own a business entirely. The capital accounts of such businesses are reflected in the financial statement as ‘Owner’s name followed by Capital Account’.
When there are many members and partners associated with a business body, it is referred to as a partnership firm. In this scenario, all the individuals use their capital and invest towards achieving the same business goals. The share of profit or loss of each partner is evaluated by either the operating contract/ agreement of LLC or by the basic articles of incorporation depending on the equity of partners.
Shareholders purchase shares of a business and get dividends depending on the total number of shares they have purchased. In a way, they share a certain percentage of the ownership. These shareholders track the profits they have earned in the capital account of the business balance sheet. In addition, they possess voting rights and the percentage of power it holds is also based on the number of shares they have.
Importance of a Capital Account
Facilitates Easy Tax Payment and Filing Returns
For a private business firm, owners have to bear taxes on the profits they have earned in a financial year. Business owners must keep a record of the profits and losses in their capital account to be aware of the total amount that they have to pay as tax. When there is a capital account, business owners know the exact amount that they have earned. This makes tax payment and return filing easier.
Avail Loans Easily
Lenders will scrutinise the capital account of business owners to know if they need to borrow funds from a financial institution. It helps them understand their financial standing and repayment potential.
Capital in accounting also helps when it comes to starting a business in partnership. This account helps in tracking the number of contributions made by each owner. It not only facilitates transparency but also ensures the long-term sustenance of business.
Tips to Maintain a Capital Account
- On-Time Payment to Providers
One of the effective ways to manage the capital account is to initiate timely payments. Clearing the payments to suppliers gives a clear idea of retained income available to owners. The accurate details of the retained earnings lower the likelihood of any payment delays. In addition, it also prevents business owners from including money that they owe to sellers in their retained income.
- Keep Proper Records
Another way owners can ensure proper capital account management is by maintaining proper records of all expenses and profits of a business. Keeping a record of these is imperative as it helps have an exact report of business earnings, dividends paid and expenses paid. Maintaining accurate reports also facilitates computing capital account balances.
- Relying on Software
Using accounting software is one of the easiest and most effective ways to maintain a capital account. The accounting software performs calculations and formatting, thereby saving time and effort. Even one can perform other business particularities like tracking expenses, sending invoices etc., via this software.
The Bottom Line
While large businesses can afford expensive accounting software and large teams of accountants to handle their finances, smaller businesses and startups may struggle with this facet of the business.
Fortunately, there are plenty of fintech solutions for startup finance problems. RazorpayX is one such solution, which helps startups supercharge their finances.
- Automate invoice management with Vendor Payments
- Easily acquire foreign capital with RazorpayX’s new Forex funding facility
- Integrate with accounting software to easily track every expense and income your business makes.
What are the different types of capital that business owners invest in their establishment?
The different types of capital that business owners invest towards establishing their ventures are financial capital, social capital, experiential capital, economic capital, manufactured capital etc.
Are there any limitations on the amount that can be drawn from the capital account of a business?
Yes, there are limitations on the amount owners can withdraw from a capital account and the time when they can withdraw. It depends on the documentation of the company which includes LLC operating agreements, partnership agreements etc. However, in the case of sole proprietorships, business owners can borrow at any time.
How can the capital account change over time?
There can be many scenarios when the balance in the capital account can change. For instance, if a business loses money, the balance from the capital accounts will reduce. In case it makes profits, the capital account will grow.
What are the main three sources of business capital?
Business capital divides into three categories, i.e., working capital, equity capital and debt capital. Working capital is the fund to meet day-to-day business operations. Equity capital arises by issuing shares and it helps expand a business. Debt capital is the borrowed fund of a business.