Welcome to the 2nd of my Bookkeeping 101 posts. These posts will cover the basics of bookkeeping and accounting, which will include definitions of financial terms (such as capital, asset, liability, etc.), an explanation of double entry bookkeeping and other insights into accounting principles. In this post I provide basic explanations and definitions of financial terms, including assets, liabilities, capital, drawings and dividends...
What is Capital?
Capital or 'invested capital' refers to the amount of funds invested in the entity by the business owner. For example, when Lisa started Business A she invested £1000 to purchase stock and pay for some business expenses. The capital invested in Business A is £1000. When Mike started Business B he invested £2000. Since then he has invested another £500. The capital invested in Business B is £2500.
What is a liability?
A liability is money owed by the business to other entities. Business A owes Lisa £1000 due to her capital investment. Business B owes Mike £2500 due to his capital investment. As the businesses owe money to their owners, capital is a liability. Other liabilities could include bank loans, bank overdrafts and business credit cards. A common liability is creditor liability, the money owed to suppliers for purchases on credit.
What is an asset?
Just as a liability is what the business owes, an asset is something than is owed to the business or something that will make money for the business. Debtors are a common asset in most businesses, customers that owe money to the business who have purchased on credit. Other assets include items that create or make money for the business such as stock and equipment. Often anything of value that can be resold is also an asset, office furniture, computers, owned cars/vans, etc. Other items that cannot be resold or are of very little value are generally expenses, these could include, power, rent, stationary, postage, wages, etc.
What are Drawings?
In a business, drawings is the term used for profits that the owner has used to pay himself/herself a wage. Generally any money taken from the business for personal use is considered drawings.
What are Dividends?
In a company, dividends is the term used for profits that have been paid out to the directors and shareholders.
Next Lesson: Bookkeeping 101: Double Entry Bookkeeping