We're all familiar with the concept of a receipt as a written confirmation that a payment has been received, whether it's made by cash, debit, or credit. Capital receipts are a bit of a different story, and understanding them requires some knowledge of the basic function of the accounting equation, the balance sheet, and debits and credits.
Capital receipts are a non-recurring incoming cash flow into your business, which leads to the creation of a liability (a debt to be paid in the future) and a decrease in company assets (resources that lead to capital gain).
3 Main Sources of Capital Receipts
Your capital receipts will come from these three sources:
- The sale of fixed assets, which are tangible or intangible property owned or controlled by your company. Fixed assets are not as readily liquidated (converted to cash) as other assets (such as a company bank account).
- The sale of shares in the business, including both common and preferred stock. (Learn more about issuing shares for your business.)
- The issuing of debt instruments to your business, such as a bank loan. (Read up on good debt vs bad debt.)
How are Capital Receipts Recorded?
You will be recording your capital receipts on your balance sheet, which is one of the primary financial statements. This will entail debiting one account (an asset account) while crediting another (a liability account). This allows the accounting equation to remain balanced, as assets are placed on one side of the equation, with liabilities on the other.
What does that look like for each of the three sources of capital receipts listed above?
- When selling a fixed asset, you will debit your cash account (the asset side of the equation) and credit the fixed asset account (thereby creating a liability).
- If you're selling shares in your business, you will debit your cash account and credit your equity account.
- In the case of the issuance of a debt instrument, you will need to debit your cash account and credit your loan account.
What are Capital Receipts Used For?
One major use of the funds originating from capital receipts is the financing of capital expenditures (aka CAPEX). They can be used to pay off existing debt as well. You can also create a reserve of capital receipts for future CAPEX/debt repayment.
Having an understanding of capital receipts can help you to get a better handle on where your company's financial health is, and also help you to plan for your business' financial future.