What is a Capital Account?
Capital refers to cash or assets (such as machinery, account receivables, property) of a business. Capital account is a type of account that records all economic transactions between residents and non-residents. It focuses on the flow of capital in and out of a country, reflecting changes in ownership of financial assets and liabilities. The transactions include both the import and export of goods and services. International payments are also carried out through capital accounts such as foreign aid and remittance.
Capital account is also beneficial in determining the net worth of a business at a particular point of time.
How does Capital Account Work?
Every company owner has a capital account, which is a key component of the company’s equity section on the balance sheet. This account represents the owner’s financial stake in the company.
- Contributions: Any money or assets that the owner contributes to the business are added to the capital account. This includes initial investments made when starting the company or additional funds provided later on.
- Profit and Loss Adjustments: At the end of each financial year, the capital account is adjusted to reflect the owner’s share of the company’s profit or loss. This means that if the business earns a profit, the capital account increases by the owner’s share of the profit. Conversely, if there is a loss, the account is decreased accordingly.
- Withdrawals: Any withdrawals or payments made by the owner for personal use are subtracted from the capital account. These withdrawals reduce the owner’s equity in the business.
Importance of Capital Account
Following are 3 major importance of a capital account in context of a business as well as a country:
- Financial Health: The capital account tracks the owner’s equity, showcasing the financial health of a company. In the case of countries, economic stability and capital flows can be determined.
- Investment and Policy Decisions: By understanding the capital account, business owners can make sound financial decisions. For countries, it guides investment policies, economic planning, and financial stability measures.
- Reporting and Planning: The capital account is essential for accurate financial reporting and planning. It helps businesses in preparing financial statements and countries in compiling balance of payments.
