Receipts are generally easy enough to understand. It marks the moment that something—like payment for receiving goods or cash—has been received. In accounting terms, receipts (capital receipts and revenue receipts) tell you a lot about a business. In fact, without receipts, there may be no existence of a business.
It’s important to know that not all receipts directly increase the profits or decrease the loss of a business. On the other hand, others can directly affect the profit or loss of your business.
So, how can you tell which receipts affect profit and loss, and which don’t?
Well, that all comes down to understanding capital receipts and revenue receipts.
At its core, both are receipts, which means both involve a transaction of some sort (aka, a buy and sell happening). However, both the nature and function of both receipts are completely different.
Here’s what we mean:
- Are non-recurring in nature which either creates the liability of the company or reduces the company’s assets
- Don’t affect the Profit or Loss of business
- Stem from non-operational sources
- Cannot save it for creating reserve funds
- Not available for distribution of profits
- Can be loans raised from banks/financial institutions
- Found in the Balance Sheet
- Example: Sales of fixed assets
- Are recurring in nature and are reported in the statement of income of the company
- Affect the Profit or Loss of business
- Stem from operational sources
- Can be saved for creating reserve funds
- Available for distribution of profits
- Are not loans, but rather, amount received from operations (e.g. running a business through sales made)
- Found in the Income Statement
- Example: Sale of products/services
Capital receipts in summary
Capital receipts create liabilities or reduce financial assets. These receipts can be both non-debt and debt receipts. Cash received from sale of fixed assets, the loan amount received by the company from a bank, and capital invested in the business by a new partner are all examples of capital receipts.
Here are two ways to find out what constitutes a capital receipt:
- Creates a liability. If your business takes a loan from a bank or a financial institution, then it would create a liability. Hence, it is a capital receipt in nature. But let’s say your business received a commission for using its expertise in producing a special type of product for another company, it would not be called a capital receipt because it didn’t create any liability.
- Reduces company financial assets. If your business sells out its shares to the public, it would help reduce the asset, which could create more money in the future. In this case, you would treat it as a capital receipt.
- Borrowing funds. As your business grows, you likely don’t have a trust fund that you can tap into using to grow and expand your business into new markets or verticals. When you take a loan from a financial institution or bank, you are essentially borrowing funds from a financial institution, which is one of the 3 forms of capital receipts.
- Recovery of loans. You have to pay back loans eventually. In order to do so, you’ll need to set aside one part of assets—which reduces the value of assets.
- Other capital receipts. Disinvestment and small savings are included as part of “other capital receipts”. Disinvestment refers to selling off one part of the business. It reduces the asset of your company. Small savings are considered capital receipts because they create a liability for the business.
Revenue receipts in summary
Revenue receipts differ from capital receipts through two conditions: it does not reduce a company’s assets and it does not create any liability.
Since revenue receipts are the opposite of capital receipts, let’s dive deeper into the key features of what makes up these kinds of receipts:
- Means for survival: You started your business operations because you expect to receive money as a result of your service or product. No matter what you do or what market you operate in, without revenue receipts, you can’t survive for long because revenue receipts are collected from the direct operations of your business.
- Applicable for a short term: Revenue receipts represent money that you receive for a short period. This means you can only enjoy the benefit of revenue receipts for one accounting year and not more.
- Recurring: Since revenue receipts offer benefits for a short period, the revenue receipts must be recurring. If revenue receipts don’t recur, the business wouldn’t be able to perpetuate for long.
- Affects the profit/loss: Receiving revenue directly affects the profit/loss of the business. When the revenue is received, either profit is increased, or loss is decreased.
- A small amount (volume): Compared to capital receipts, the number of revenue receipts is usually smaller. That doesn’t mean all revenue receipts are smaller. For example, if a company sells 1 million products in a given year, the revenue receipts could be huge and could also be more than its capital receipts during the year.
Understanding the difference is key
Understanding these two concepts, when they occur, and how they affect your business will help you run your everyday operations much more effectively. For example, if your business is growing rapidly and will need to borrow money—whether that’s through the bank or through an IPO—your capital receipts will reflect that. If your revenue receipts are lacking in both occurrence and volume, then you’ll know to look into borrowing funds instead and decreasing overhead, where possible.
Knowing the difference between the two will also help investors make a prudent decision about whether to invest in your business or not. If your business has fewer revenue receipts and more capital receipts, investors need to think twice before investing. If your business has more revenue receipts and fewer capital receipts (occurrence, not volume), investors can much more likely take the risk because the business is now beyond the level of survival.