Journal Entry for Withdrawal of Capital
Capital refers to the amount of assets that the owner invests in the company in order to generate income. This can include cash, property, equipment, or even intellectual property.
Capital is essential for businesses of all sizes, as it allows them to finance their operations and expand their business activities.
Without capital, businesses would be limited in their ability to grow and generate profits. While there are many sources of capital, the most common is debt financing. This involves taking out loans from banks or other financial institutions in order to purchase assets and expand operations.
Equity financing is another common source of capital, which involves selling shares of ownership in the company in exchange for funding. Whatever the source, capital is essential for businesses to thrive. The level of a company’s capital can have a big impact on its ability to make a profit. When a company is making a profit, its equity will usually increase. This is because the company will have more money available to reinvest in its business. As a result, a company’s capital can be seen as a key indicator of its financial success.
As the owner of a small business, you have the option to withdraw capital from the company at any time. However, there are a few things to consider before making this decision.
First, withdrawing capital can reduce the amount of money available for reinvestment or for meeting other financial obligations. It may be difficult to replace the capital later on if needed. Finally, withdrawing capital can send a signal to investors that you are not confident in the future prospects of the business.
As a result, it is important to weigh all of these factors carefully before deciding to withdraw capital from your company.
Journal Entry for Capital Withdrawal
The withdrawal of capital will impact the company’s equity on the balance sheet. It will decrease the amount of capital and cash on the balance sheet.
The journal entry is:
| Account | Debit | Credit |
|---|---|---|
| Capital | XXX | |
| Cash | XXX |
The cash will be transferred to the owner of the company. The amount of capital will be decreased from the balance sheet as well.
Example
Mr. John is the owner of the company ABC which has been doing good for several years. Mr. John has decided to withdraw the capital amount $ 20,000 from the company for various reasons. Please prepare journal entry for capital withdrawal.
The company needs to pay cash $ 20,000 to the owner, Mr. John and it will reduce the capital from balance sheet as well.
The journal entry is debiting capital $ 20,000 and crediting cash $ 20,000.
| Account | Debit | Credit |
|---|---|---|
| Capital | 20,000 | |
| Cash | 20,000 |
The entry will decrease cash amount $ 20,000 and the capital will decrease by $ 20,000 as well.
Reasons for Capital Withdrawal
Capital withdrawal is the removal of capital from a business for different reasons such as creating distributable reserves, returning surplus capital, and de-merger.
- Creating Distributable Reserves: A company can withdraw some capital to be converted into distributable profits or retained reserves in order to increase the return on equity. This is done to provide dividends to shareholders or take preemptive action in case of contingency losses that may arise in the future.
- Returning Surplus Capital: If a company has excess capital in its operation, it is beneficial to withdraw this excess money and give it back to its shareholders as share repurchases or dividend payments. This way the company is able to improve its financial condition by reducing the total capital base and increasing the rate of return on equity.
- De-Merger: Sometimes a company needs to break down into two distinct entities for strategic operations such as de-merger, spin-off, carve out, etc. In such cases, companies are expected to make necessary arrangements for associated changes like transferring assets from one entity to another and raising money through selling part of either entity’s shares, which includes withdrawing some capital.
- Simplifying Capital Structure: A complex financial structure, involving capital withdrawn from different sources increases cost and complexity, thus hindering the smooth functioning of a business enterprise. Therefore companies often redraft their financial structure by withdrawing some amount from their existing sources of finance which simplifies complexity and makes operations smooth.