What Is Capital? | A Guide for Your Small Business Accounting
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What Is Capital? – A Guide for Your Small Business Accounting

Whether you have owned your business for one day or 30 years, you always need capital. If you are a new business owner concerned about your small business accounting, you know that you need funds to get started. And if you own an established company, you know the hunt for resources doesn’t stop after you get your business off the ground.

Understanding capital can help you with growing a small business, no matter what stage you might find yourself. It’s important to know the worth of your company and to create an accounting plan to gain more.

The easiest way to keep track of your capital is by using accounting software for small business, but some small business owners may prefer to do it manually.

Capital Definition:

Capital includes the cash and other financial assets held by an individual or business, and is the total of all financial resources used to leverage growth and build financial stability. Capital can include funds held in deposit accounts, tangible machinery like production equipment, machinery, storage buildings, and more. Raw materials used in manufacturing are not considered capital.

Some examples are:

  • company cars
  • patents
  • software
  • brand names
  • bank accounts
  • stock

Capital is not the same as money. Instead of simply spending it like cash, you use it to create wealth through investment.

Since you use capital to create wealth, it is considered an asset in your small business accounting records. Assets are items that add value to your business. Your assets are also items that help you produce the goods and services you sell (e.g., equipment).

Capital gains and losses

When you invest, the capital will generate wealth for your business. And as your investments help grow your business, the capital itself grows in worth. These changes are gains and losses.

Capital gain example

When your worth increases, you see a capital gain. This occurs when your investment is worth more than its purchase price.

For example, you buy a truck for $1,600 to help you move equipment for your lawn care company. The truck needs work, but you fix it without needing any new parts. You then turn around and sell it for $2,000 because, by fixing it, you gave it a higher value.

To calculate the gain in your small business accounting records, you take the final sale price of the truck ($2,000) and subtract your initial purchase price ($1,600). So your accounting records should reflect a gain of $400.

Capital loss example

When your worth decreases, you see a capital loss. This happens when your investment is worth less than its purchase price.

With the lawn care company example, let’s say you still buy a truck for $1,600. As you work on it, you realize it will cost more money than you planned. You spend $800 on new parts, but you then sell the truck for $2,000. Between the cost of the truck and parts ($1,600 + $800), you spent a total of $2,200.

To calculate the loss in your small business accounting records, you take the final sale price of the truck ($2,000) and subtract your total investment into the truck ($2,200). You should have calculated a negative $200, and this should be reflected in your accounting records by a loss of $200.

Growing capital

Many small business owners fund their own capital when starting their businesses. Sources for startup funding include personal savings and zero interest credit cards.

You might also try to get a small business loan from a bank or credit union by presenting a business proposal. Venture capital firms may help you grow your company in return for equity or partial ownership of your business. SBA programs offer financing options for small businesses, usually with loan guarantees. Look into some small business loan tips to give yourself a better chance of locking down this type of business capital.

Once you establish your business, you begin gaining funding from other sources. You should gain capital primarily from your profits. As you gain equipment, property, and other assets, your capital grows. When it grows, the worth of your business grows.

Recording capital expenditure

Capital expenditure is the amount of money you spend to gain fixed assets. Fixed assets are for long-term use and do not convert quickly into cash (e.g., land, building, equipment).
As a small business owner, you need to record your capital expenditures. Tracking your investments accurately shows your company’s worth, and you need that figure for more than bragging rights. Keeping a small business accounting checklist handy can be a big help.

Here are some examples of when your capital records matter:

  • You need these records to get a bank loan or talk with investors. These records help others decide if they will invest in your company.
  • You may decide you want to insure some of your investments. The insurance company will need details about their worth to insure them.
  • Capital shows you what financial choices have helped your business in the past. It can also help you plan for the future. It shows you what financial choices are reasonable plans. Your accountant can help you understand your capital records for these decisions.

Be sure to record all your investment transactions in your financial records. Use financial statements such as a balance sheet, profit and loss statement, and cash flow statement to track capital expenditures.

Working capital

Working capital is a specific kind of capital in your business. You use working capital to pay for the day-to-day operations of your business.

Working capital converts into cash more quickly than other investments (e.g., a new oven at a bakery). This means working capital is moving in and out of your business more quickly, so be sure to keep up with recordkeeping.

Small business accounting takeaway

Often, small businesses do not have a lot of room to make large financial mistakes. Understanding your capital records can mean the difference between a savvy investment and an error in judgment. Take a look at these records before you make your next big financial move.

Did the capital you invested in grow your company? Are you in a place financially that you can invest more in your company? You can learn answers to these questions by recording and examining your investments.

When your capital is growing, so is your business. Build a solid strategy for tracking, using, and gaining investments.

Spare yourself the time and frustration involved in keeping track of your small business capital. Try our online accounting software for cash basis recordkeeping. Get a free trial today.

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