What is a Capital Account?
The capital account of a company is an important part of its accounting since it indicates whether the company is attractive for investments or not. Essentially, it involves an account of all the company's remittances, cash flow, and asset ownership and distribution amongst the stakeholders.
The capital account comes under the topic of macroeconomics and plays a vital role in understanding the financial situation of LLCs, SMEs, and even a country itself. The capital account of a business provides an indication of its current net worth. In the case of single proprietorships and in corporations, the capital account also denotes the shareholders' equity and the owner's equity. SMEs usually have sole ownership, which makes the company's capital account a description of the owner's overall holdings and the company's overall business earnings.
Typically, companies include information on their capital accounts at the bottom of their balance sheets. The equity distribution is then done according to the ownership of the company. To be thorough with stakeholders, companies with multiple ownerships have multiple capital accounts for various owners to track the accounts of the company and the individual earnings.
How Does A Capital Account Work?
Source: Wall Street Mojo / Capital account statement
Company founders and VCs usually have capital accounts, which are updated regularly to revise the earnings of every individual stakeholder in the company. Technology and macroeconomics have taken over, and software is used to create a capital account.
In the case of SMEs, capital account creation is not much of a hassle as the equity distribution is not much. Usually, the company's accountants log every transaction made by the company and reassign the remaining income to the owners in their capital accounts to make the process smoother.
Changes in taxation, sudden expenses, or discrepancies within the company typically impact the organization's capital account. As a result, ownership agreements between stakeholders abide by all adjustments made to capital accounts.
Salt, a neo banking solutions firm, works on providing services related to remittance and table–compliance handling. The company offers services to LLCs and other corporations and takes care of the majority of its clients' banking needs through fully automated online procedures. As a result, Salt can provide assistance if there are issues with the company's capital accounts.
Benefits of understanding how capital account works
A clear understanding of the capital account keeps shareholders in the loop of their position in the company and their profits.
Understanding how capital accounts work allows SMEs to better manage their funds and steer clear of unwanted debts.
Startup founders can better understand business transactions, shareholder equity, and other concepts through capital accounts.
Types of Capital Accounts
Based on the kind of ownership of a business, there are mainly four types of capital accounts. These are:
Sole proprietorship
Such a capital account is maintained in the case of a single-owned business in which the capital gains are accounted to a single entity. This type of account is displayed with the owner’s name on the balance sheet.
Partnerships/LLCs
In a business with multiple partners with different investments in the business, LLC capital accounts are created for each partner. The capital gains or losses are determined by the LLC operating agreement and thus reflected on individual accounts.
Shareholders
In a business, shareholders with considerable capital investment also have capital accounts. They are compensated by the business in terms of dividends and also get voting rights since they have a fair share in the company.
S and C corporation accounts
In the case of both S Corporation and C Corporation, capital accounts are maintained by mentioning the law deductions, transfer of profits to the shareholders, and other transactions. These capital accounts are maintained for all the shareholders after mentioning different tax deductions.
Why is a Capital Account Important for Business?
A capital account keeps a clear track of the funds of the business. When a company founder applies for a loan, banks usually look at the capital accounts of the company to understand the company's financial stakes and ability to repay the loan. The capital account of a company also keeps track of funding from different sources and how much equity is distributed to each owner on its behalf.
Taxation levied on the business’s owners is another reason for maintaining a capital account. In the case of sole ownership, a company founder has to pay taxes from the capital gains mentioned in the capital account. On the other hand, corporations and businesses with multiple stakeholders have different tax filing systems. Shareholders receive capital gains in the form of dividends and stocks. Earnings from dividends and selling stocks attract taxes that must be paid under the tax laws of the region. All of these calculations can be effectively done only if the company's capital account is well maintained.
Conclusion
Certainly, the capital account of a firm is the foundation for comprehending the capital gains of the business's owner or shareholders. Moreover, it takes precedence since it helps keep track of all the transactions and expenses. Maintaining a clear record of the transactions also helps keep the finances clear and thus maintain the financial stability of the business.
