What Is a Capital Account? (With Helpful Examples and Tips)

By Indeed Editorial Team

Published May 31, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

It's important for professionals to use a balance sheet to track their profits and losses accurately. Balance sheets include accounts used to monitor the financial health of a business, and one of the most important accounts on a balance sheet is a capital account. If the company you work for tasks you with creating an effective and accurate balance sheet, you can benefit from learning more about these accounts. In this article, we identify what a capital account is, explain how it works, share why it's important in business, and provide some examples and helpful tips.

What is a capital account?

A capital account tracks retained earnings from one accounting period to the next. When you balance a company's accounts after paying expenses, the amount of money remaining is the company's retained earnings. Often, companies transfer this money to their account to create an accurate and updated record of their earnings.

Typically, companies report these accounts at the bottom of their balance sheets. If a company is a sole proprietorship, meaning it's owned by one person, this balance sheet section may refer to this account as the owner's equity. If the company is a corporation, meaning a group of shareholders owns it, the balance sheet may refer to this account as the shareholders' equity. With shareholders' equity, companies also subtract shareholder dividends, or the shareholders' portion of earnings, before calculating retained earnings.

Related: What Is a Balance Sheet? FAQs, Components, and an Example

How does this account work?

You can create this account using a spreadsheet or specific accounting software to log all company transactions. It's essential to record all income and expenditures for the business to have an accurate total of funds in the account. Consider creating an account section on the balance sheet and adding the owner's investments in the company to the account. Then, update the account by adjusting for profits and losses of retained earnings for each budgetary period. Try to account for any additional investment from owners, including cash investments or assets purchased for the company, such as land.

If a company is a sole proprietorship, it often only has one of these accounts. Conversely, if it's a partnership, meaning a private company with two or more owners, it may have an account for each owner. When each owner has an account, it can help you track accounts for individual members based on the amount of funds allocated. For example, if one partner owns two-thirds of a company, the company may give that partner two-thirds of the retained earnings. If the company has shareholders, you can pay dividends to them from a single account.

Related: Everything You Need to Know About Account Managers (With Salary)

Why is this account important in business?

This account is a way to measure the revenue a company has made in a particular budgetary period and track each owner's investments. Here are some ways this information can help you:

Bank loans

If someone starts their own business, they can apply for a loan. To acquire a loan, the owner's bank may request to see any funding they've previously invested to make sure they have a financial stake in the company. Viewing an entrepreneur's investments in the company informs the bank of their dedication to the business and likeliness to repay a loan.

An account shows a business owner's starting investments in their company. Owners can share their account information with the bank by supplying their bank statements or balance sheets. If the bank grants them a loan, they can record the amounts in the bank's section of their balance sheet.

Contributions

If professional partners with other individuals to start a company, they can track how much each partner invests using an account. All owner's initial contributions to the company are capital contributions, which they can record in the account. Regarding property contributions, an owner usually assigns a monetary value to the property and adds this value to the capital gains account.

Usually, an owner's contribution increases their equity interest in the company or their owned percentage of the company. For example, if one partner contributes one-third of the capital, they own one-third of the company. If another partner contributes one-fifth of the capital, then one-fifth of the company belongs to them.

Related: Debt vs. Equity Financing (With Types and Example)

Taxes

If shareholders don't own a private company, it's typical for its owners to pay taxes on the distributed profits they receive. All owners claim the distributed profits they earn during the year on their personal tax returns. It's crucial for company owners to monitor the profits and losses in their accounts to understand the correct amount they owe each year in taxes.

Corporations, or businesses owned by shareholders, pay corporate income taxes. The government taxes corporate income, or capital gains, in the following manners:

  • Dividends: If a shareholder receives a dividend or payment from an account based on their share in a company, this dividend or payment is a capital gain. The shareholder pays taxes based on the capital gains tax in their specific location.

  • Stock: If a shareholder sells their stock in a company and receives a profit, they pay capital gains on that profit based on the tax rates in their area.

Examples of capital accounts

Here are some different capital gains accounts with descriptions of each:

Partnerships and limited liability companies

When multiple people invest capital and own a business together, each partner typically has their own account. They often split the retained earnings between the accounts based on their partnership agreement. For example, if Laura and Chris decide to open a bar together in a building that Chris owns, they may agree that Chris owns two-thirds of the bar. Their balance sheet may read: Chris, the account receives two-thirds of the earnings, and Laura, the account receives one-third.

Shareholders

Shareholders buy ownership of a company and receive dividends based on the number of shares they own. For example, Tech4000 is a corporation that has 50 shares. The company records its retained profits in an account and regularly pays dividends to its shareholders. Micah, who owns 25 shares of Tech4000, receives 50% of the dividends from Tech4000's account.

Related: What Is Equity in a Company? (With Definition and Types)

Sole proprietorship

A sole proprietor has full ownership of their business. For example, Debra opens a flower shop, invests her money into the company, and applies for a bank loan to rent a space. Since she is taking these steps alone, she is the sole proprietor of the flower shop. Therefore, the flower shop's balance sheet account may read: Debra, capital account.

Tips for managing this type of account

Here are some valuable tips that can help you create an accurate and effective balance sheet:

Maintain accurate records

The most important aspect of successfully managing an account is maintaining accurate and detailed records of all profits and expenses. If you balance the accounts, these records are crucial to ensuring you have a reliable report of the business' earnings, dividends, and overhead costs. You can use this information to calculate the account.

Monitor receivables

When managing this account, it's important to monitor all receivables. Receivables are the payments that other clients or companies still owe. If you closely monitor these amounts, you can improve how the company collects its profits. For example, you may choose to send invoices as soon as possible and frequently communicate with the clients. When the company receives profits to which its allocated assets, balancing its accounts is more efficient. This efficiency can allow you to focus on making new sales.

Pay vendors

It's important to pay vendors within a reasonable timeframe as this can reveal the company's retained earnings. Paying on time can reduce the chance of paying interest or fees for missed payments and prevent you from accidentally counting money in the retained earnings that the company may eventually pay to its vendors. This practice may help you retain accurate records and prevent fraud charges. When the company pays vendors on time, it can strengthen the working relationship between them.

Related: What Is a Profit and Loss Template? (With Types and Example)

Use software

Use accounting software to make sure you manage the company's accounts correctly. Such software may also save you time and effort as it typically formats and calculates amounts for you. Sometimes, accounting software helps with other processes, like sending invoices. As there are many types of accounting software available, you may compare them before deciding which one best fits your needs.

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