For financial accounting purposes, journal entries provide the basis for all changes in the cash balance that companies report on a balance sheet. When you start a new company, the first journal entry you make must reflect the sources of your initial opening cash balance regardless of whether it’s from a loan or an investor. However, once you begin operations, it’s also important to understand the journal entries that are necessary to account for the inflows and outflows of cash.
Opening Cash Balance
All new companies need cash to stay afloat until the business is fully operational and generating income. Initially, you may contribute personal funds to operate your business, obtain bank financing or have private investors who take an ownership interest in exchange for cash contributions. Regardless of where the money comes from, you need to make the proper journal entry to ensure your books and records are accurate, making it possible to trace the source of each dollar you receive and project with reasonable accuracy whether you will encounter cash flow issues in the future. However, a preexisting company will not make a journal entry to reflect the opening balance of cash since it’s always equal to the closing balance at the end of the prior fiscal year.
Debits Increase Cash
There are two sides to every journal entry: a debit and a credit. When dealing with an asset account, such as cash, a debit entry to the account will increase its balance, while a credit entry will decrease it. The entry to record the opening balance of cash always requires a debit entry equal to the amount of cash your company receives. However, the trickier side of the journal entry is crediting the appropriate account.
Entry for Financing
When your company receives part of the cash as a result of a loan or other bank financing, the credit side of the journal entry must increase a liability account to reflect the debt. Before making the credit entry, you must evaluate whether the debt must be repaid within one year or at some time after. If repayment is necessary within one year, the credit entry you make must be to a current liability account, such as short-term debt obligations. However, if the loan is long-term, you make the corresponding credit entry to a noncurrent liability. Once both sides of the entry are complete, your balance sheet will reflect the inflow of cash from the loan but also increase the liabilities of the company.
Entry for Investors
Another common way for new companies to generate an inflow of cash is from investors who want to purchase an ownership interest in the company. This also includes the cash you contribute to the company with your personal funds. Regardless of who the investor is, the credit side of the journal entry is made to an equity account. The balance in the equity account will increase to reflect the value of the investments you receive, including those that are made with property rather than cash.