Recording Cash Investments: A Step-By-Step Guide For Beginners

Recording cash investments is an important aspect of financial management for any business, whether it's a sole proprietorship, a partnership, or a corporation. Properly documenting these transactions helps maintain accurate and up-to-date company accounts. In a sole proprietorship, when an owner invests their personal funds into the business, it is recorded as an owner investment. This can be done through a designated “contributed capital” account in accounting software, which tracks these funds. For partnerships, individual accounts for each owner, such as Contributed Capital - OwnerName, are created to record their investments. Corporations, on the other hand, often involve issuing shares to shareholders in return for their investments, and these transactions are recorded accordingly. Accurate recording of cash investments is crucial for financial transparency and decision-making within a business.

Sole proprietorships

A sole proprietorship is an unincorporated business owned by one person. It is the simplest form of business organization to start and maintain. The business has no existence apart from the owner, and its liabilities are the owner's personal liabilities.

When recording a cash investment as a sole proprietorship, it is important to keep business money separate from personal money. This means that most owners will have a business bank account and a personal bank account. When a business first starts, money is usually put into its business bank account from the owner's personal funds. This is called an "owner investment".

To record an owner investment, you will need to debit cash and credit the owner's capital. For example, if the owner invests $10,000, this amount will be entered as owner's equity on the business's balance sheet. It will also be entered as a cash asset, so the equation balances out.

If the owner lends money to the business, the entry will be to debit cash and credit a liability account. This is because the business owes the money to the owner and intends to pay it back.

It is important to note that the form of business determines which income tax return form you need to file. A sole proprietorship includes the income and expenses of the business on the owner's personal tax return.

Common stock

When recording a cash investment for common stock, the first step is to understand the nature of common stock. Common stock is the most basic form of ownership in a company. For example, when you buy a share of Apple stock, you are buying common stock. Common stockholders have ownership in the company and voting rights. However, in the event of bankruptcy or liquidation, common shareholders are last in line to be paid out.

Now, let's discuss how to record a cash investment for common stock. When an owner invests cash in a company in exchange for common stock, the journal entry involves debiting Cash and crediting the Common Stock account. The number of shares issued multiplied by the par value of each share is credited to the Common Stock account. The par value is the stated value of a share of stock as printed on the stock certificate, and it can vary from one cent to $100 per share.

If the company sells the shares for more than the par value, the additional amount received is credited to the Additional Paid-in Capital (APIC) account. On the other hand, if the company sells the shares for less than the par value, the difference is debited from the APIC account. This ensures that the journal entry remains balanced, with the total debits equalling the total credits.

For example, if a company sells 500 shares with a par value of $5 per share for $20 each, the journal entry would involve debiting Cash by $10,000 (500 shares x $20) and crediting Common Stock by $2,500 (500 shares x $5 par value) and crediting APIC by $7,500 (reflecting the excess amount received).

It is important to note that the recording process may vary depending on the specific circumstances and regulations in your jurisdiction. Consulting with an accounting or financial professional is always recommended to ensure accurate and compliant financial reporting.

Dividends

When a cash dividend is paid to shareholders, this is known as the payment date. Since the dividend liability was previously recorded on the dividend declaration date, the journal entry on the payment date would be to debit dividend payable and credit cash (for the cash outflow). The journal entry on the declaration date would be to debit retained earnings and credit dividend payable.

For an investment reported under the equity method, any dividends received from the investment would represent a decrease in the investment's asset balance on the balance sheet. The company will also receive an inflow of cash from the dividends received. For example, if the company received a $15,000 dividend, the company would debit cash and credit the investment asset.

Assuming the company uses the fair value method and not the equity method or consolidation method, the company would record dividend income from an investment by debiting cash and crediting dividend income. Dividend income would be classified as a non-operating gain in the income statement.

Capital expenditures

CapEx is important for companies to grow and maintain their business by investing in new property, plant, equipment (PP&E), products, and technology. Financial analysts and investors pay close attention to a company’s capital expenditures as they do not initially appear on the income statement but can have a significant impact on cash flow.

The decision of whether to expense or capitalise an expenditure is based on how long the benefit of that spending is expected to last. If the benefit is less than one year, it must be expensed directly on the income statement. If the benefit is greater than one year, it must be capitalised as an asset on the balance sheet.

There are three types of business expenses recognised by the Internal Revenue Service (IRS) as capital expenditures: business startup costs, improvements, and the acquisition of long-term assets.

The formula for calculating capital expenditures is as follows:

> CapEx = Current PP&E – Prior PP&E + Current Depreciation

Or

> CapEx = Change in PP&E + Current Depreciation

The cash flow to capital expenditures ratio measures the ability of a company to purchase capital assets using the cash generated from its operations. A high ratio reveals that a company has a lesser need to utilise debt or equity funding since it has enough cash to cover possible capital expenditures.

Cash flow statement

A cash flow statement is a financial report that details the inflow and outflow of cash and cash equivalents in a business during a specified reporting period. It is one of the three fundamental financial statements used by financial leaders, alongside the income statement and balance sheet.

The cash flow statement is typically divided into three sections:

• Operating Activities: This section details the cash flow generated from the company's regular goods or services, including revenue and expenses. It includes cash collections from sales, cash paid to suppliers, employee salaries, and other operating expenses.
• Investing Activities: This section covers the cash flow from purchasing or selling physical and non-physical assets, such as real estate, vehicles, patents, etc. It includes the acquisition and disposal of long-term assets and investments, excluding debt-related transactions.
• Financing Activities: This section details the cash flow from debt and equity financing, including cash inflows from issuing stocks or debt and outflows from repaying debt or buying back stock. It also includes transactions related to dividends and repayment of loans.

The cash flow statement can be prepared using two methods: the direct method and the indirect method. The direct method involves listing all cash receipts and payments during the reporting period. The indirect method starts with net income and adjusts for changes in non-cash transactions, such as depreciation and amortization.

The cash flow statement provides valuable insights into a company's financial health, operational efficiency, and liquidity. It helps investors, creditors, and business owners make informed decisions and assess the company's ability to fund its operations, pay debts, and invest in future growth.

Frequently asked questions