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Business owners often wonder what is capital in accounting? In the simplest terms, capital is what enables your business to generate some form of value. Examples of capital include bank accounts, patents, bonds, machinery, brand names, and stocks. Many types of capital exist such as trading capital, working capital, equity capital, and debt capital. Capital is often associated with a certain cost. For instance, equity capital takes into account the cost of distribution that is made to the various business shareholders. In the case of debt capital, the cost associated with it will be the interest that will be paid.
Capital must not be confused with cash because capital does not equate to cash at all times although both are valuable to your business and are essential components. In some cases, capital can be more valuable than cash because you can generate more money with it such as when you invest. Capital is an asset because of its ability to add value. Capital in accounting can be determined by looking at your accounting records. Using a reliable software solution like TallyPrime will ensure each record is accurate and trustworthy. This will enable you to make wise decisions based on where to invest and how much to invest.
A capital account is considered a general ledger account which is included in the balance sheet. It will be described in the stockholder’s equity in the case of a corporation and if the business has a sole proprietorship, then it will come under owner’s equity. The capital accounts total must be the same as the business liabilities subtracted by the assets. That is, each of the balances of the capital accounts need to be added first. Then this number should be the same as the total assets minus liabilities of your business. Note that the result that you get when you add all the capital accounts will not be a realistic indication of your business’s value.
An example of a capital account will be retained earnings in the case of a corporation. This constitutes the earnings after dividends distributed have been subtracted. Other capital accounts that corporations will generally have include treasury stocks, common stocks, paid-in capital, preferred stock, and so on. If it is a sole proprietorship business then you can expect two types of capital accounts; a drawing account which will have the information of how much was drawn. Another would be the capital account that is increased when the investment amount is added to the net income. It will decrease by the drawing account’s debit balance.
When it comes to capital accounts, the type depends on the business. The following are the major types of capital accounts that are required for different types of businesses.
In this scenario, only one person or one proprietor has complete ownership of the business. Let us say you own a store where you sell pet food. If you have saved up and then brought the required pet food that you can sell at your store then it means you are investing your money into your business. This will mean you are the sole proprietor. Even if you have taken a loan from the bank, you will be the sole proprietor of your business because you are the sole owner of the business as your money is going into getting your business up and running. In your balance sheet, the capital account will be stated as Your Name, Capital Account.
Partnerships and LLCs
When more than one person is involved in the business it is called a partnership. In such a scenario, all of these people are investing in the business using their own capital. How the retained earnings will be divided is discussed in advance and often depends on the capital invested by each individual. Let us say you, Harry, and Lauren decided to open a bakery. Harry has invested more capital and so he will own 2/3rd of the business. While the remaining 1/3rd is split between you and Lauren. Hence, you and Lauren will receive 1/6th of the earnings each and Harry will receive 2/3rd of the earnings.
Shareholders own a certain portion of the company. That is, they buy the ownership of the business. They are then eligible to receive dividends which depends on how many shares they have purchased of your business. Let us say Forever Mode has 100 shares. They keep a record of the profits they earn in their capital account of their balance sheet. When the time comes, dividends are paid to the various shareholders of Forever Mode. If Darren owns 50 shares, he gets 50% of the dividends. Someone with 10 shares will get 10% of the dividends and so on. All of this is recorded in the capital account of your business’s balance sheet.
When you are the sole proprietor, there is going to be only one capital account. That is yours. When you have shareholders for your business then you can still work with a single capital account because you will be paying them based on shares owned by each. When you are working in a partnership whereby there is more than one owner of the business, then there will be a separate capital account for each owner. This will enable you to ensure the correct retained earnings are being allocated according to the capital that each owner invested. It makes it much easier when you have a software solution like TallyPrime.
There are numerous ways to create a capital account. The key to ensuring proper calculations is to record every single transaction of your business. This is best done with tools such as TallyPrime that are built to automatically store and record every transaction. You can create a capital account with ease on your balance sheet. Thereafter, when required, you can adjust the profits along with the losses for each period.
The capital account is important for various reasons. Here are the top reasons why capital accounts are vital for every business.
If you are a private business then you will need to pay taxes on the profits you earn from selling goods and services. When it comes to filing for your tax return, you will do so on the profits that you earned. When you have a capital account, you know exactly how much profit you earned and the losses that were incurred during the financial year. This makes it easier for you to pay your taxes and file for returns. For those businesses which have shareholders, you are supposed to pay corporate taxes. There are many ways in which this can be done. The two most common ways are through stock and dividends.
As a start-up you might need to take a business loan. The bank will need to see some proof that you will be able to repay the loan on time. For this, the capital account will come in handy because it will show that you have invested in your business. You can show the balance sheet of your business as proof. Banks usually ask for evidence that you have made investments as it proves to them that you have the ability to pay back the bank loan. This will give them the confidence they need to approve the loan amount that you require. Hence, a capital account is quite useful when it comes to applying for bank loans.
A capital account is beneficial when it comes to starting a partnership whereby there is more than one owner of your business. It is easy to lose track of calculations. But when you have a capital account from the beginning, you are able to keep track of which owner invested how much. This enables you to always know how much stake each partner holds in the company and makes it easier for the long-term of your business as well. Capital account is particularly useful when it comes to property contributions as well because a value is assigned to each property.
TallyPrime is a primary accounting and business management software for MSMEs that can be used to generate over 400 reports so you can thoroughly understand your business. TallyPrime comes with several default groups and one of those is capital account. The ledgers that fall under this include share capital, proprietor’s capital account, and partners’ capital account among others. TallyPrime gives your business the flexibility to create capital accounts and derive as much knowledge through reports as possible so you can make the best business decisions in the nick of time. It enables you to do much more such as manage inventory, payroll, assign permissions, taxes, and more.
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