Chapter 5: Basic Accounting
Capital accounts are an easy way to keep track of how much money the business owners invest or receive from the business. Capital accounts aren’t like an account you open at a bank, but instead a general accounting practice of keeping written records for a business owner’s stake in the company. This is important information for general bookkeeping, but will also be necessary if you intend to obtain a business loan or investment, as investors or banks will want to see a clear outline of who the owners are, and their equity.
Capital account balances will change over time, adjusting to accommodate additional owner contributions or distributions of profits. Here are some events that can affect the balance of a capital account, but keep in mind that some companies may elect to institute some fine print or complexities that may adjust how capital accounts are recorded:
Owner Contributions: The value of a capital account increases when an owner makes contributions. For example, an owner might invest money or contribute other types of assets when the business opens. The owner may also make regular contributions throughout the life of the business.
Business Losses: When the business loses money, each capital account is reduced according to the business’s governing documents.
Business income: As the business earns profit, each capital account is increased proportionally.
Owner distributions: Owners might be able to withdraw money from the company’s profits for personal use. You’ll subtract from an owner’s capital account accordingly when they take distributions.
Annual reconciliation: At the end of your business’s fiscal year, your bookkeeper should add or subtract from the capital account to reflect the owner’s share of the net profit or loss.
Each capital account should track the partner’s:
Cash contributions or the fair market value of assets—like property, vehicles, and equipment—contributed during the year
Share of the partner’s profits and losses
Distributions for personal use
Take a look at the following example: Let’s say two people form a limited liability company and decide to split ownership down the middle—each taking 50% of the profits and losses. Each owner invests $25,000, so each capital account starts out with $25,000.
The business does well during the first year and earns $60,000. Each owner’s capital account increases by $30,000 for an account balance of $55,000 per owner. But during the year, Owner A and B each took $10,000 out of the business for personal use. Here’s a simplified look at how the changes might be tracked:
