What Capital and Cash Partners Need to Know About Capital Accounts
If you want to borrow money to help start your business, when you go to a lender, they will want to know you are invested in your new venture. Opening and maintaining a capital account proves to lenders that you have a stake in your business and you and your capital and cash partners aren’t likely to borrow money and not pay it back.
Whether you are planning to establish a business as a sole proprietorship or a limited liability corporation, it makes sense to begin contributing to a capital account, which is an account that establishes stakeholders ownership in a company, right away.
Understanding capital
All businesses hold many different assets, known as capital. Capital includes cash, vehicles, buildings and property, equipment, computers, and office furniture. The accumulated wealth in a business or the owner’s investment also are considered capital. Except for really low-cost items, a business must maintain detailed records of its capital items to maintain control of the assets and for determining taxes.
What is a capital account
A capital account is an equity account that is used to monitor the net investment balance of every owner that contributed to the account for business purposes. Equity often is called net assets because whatever is left after liquidations goes to its owners. When there is a single owner, there is a single capital account that contains the owner’s equity. If there is an limited liability corporation (LLC), each partner has a capital account. Many businesses with a small number of partners, such as a law firm, likes to incorporate themselves as LLCs because no owner is personally responsible for debts and liabilities. Therefore, with an LLC, you can’t lose more than you have contributed.
A capital account will show every investment made by the owner or partner, any future business profits or losses, any subsequent amounts paid to an owner or partner, and the ending balance. The account’s ending balance is the amount that has not been distributed among the partners as of that date. Typically, the ending balance usually is a credit balance. Many times, the only possible way for the account to have a negative balance is if a business has received debt funding to offset the loss of capital.
A breakdown of a sample ending balance
To calculate an ending balance, you would add your initial contribution with your agreed upon profit allocation. Any distributions would be subtracted from that amount. Therefore, if a member of a LLC originally contributed $50,000 to a business, was allocated $30,000 of its future profits, and already received a distribution of $15,000, the ending balance in this account would be $65,000.
If you have partners, it is especially important that you keep detailed records of these amounts. Records reduce the number of issues the parties may have over payment distribution amounts or liabilities if the business is liquidated or one of the partners leaves.
The amount cash and capital partners should contribute and terms
When it’s time to make a contribution, what is appropriate for each partner? Ideally, all partners in an LLC should put up equal amounts to cover the initial expenses of the business. If additional contributions are needed, any credits to the members’ account should show any changes. Through the life of capital accounts, you can deposit or withdraw money from the account. However, there limitations as to how and when withdrawals can be made. It is a bad move to draw more than the capital that a partner has available. Doing so could leave the business with cash-flow problems.
All terms related to capital accounts should be outlined in the business’ operating agreement. Since each business is different, the terms of each agreement varies. In most cases, capital account percentages are calculated based on the individuals’ capital accounts based on income, loss, and distributions.
Finally, a capital contribution should not be confused with an owner loan to a business. As previously mentioned, a capital contribution is an equity account that represents business ownership. An owner loan is when a business borrows money from an owner. This type of loan doesn’t establish ownership.
One Last Thought
Starting a new business is exciting, challenging, and, oftentimes, expensive. Establishing and maintaining a capital account is a good way to show you are serious about your endeavors. It is difficult to borrow money if you are just starting out and you haven’t established much credit. Having a capital account will prove to lenders that you are willing to put your own money on the line to ensure your business thrives.
The bottom line is to set your business up for success through preparation. Make sure you begin laying the groundwork by setting up a capital account.
When you are ready to set up a capital account, turn to First American Merchant (FAM). Its application process is quick and simple. Also, it is known for offering solutions that help merchants get whatever they need to build their businesses and grow.