Given the circumstances, it should come as no surprise that more businesses are seeking out loans in order to keep themselves afloat. Most businesses borrow capital to keep going, so knowing how loans work and how to record them is essential for keeping your books accurate. That is why we at From Red To Black LLC are going to teach you how to record loans in your bookkeeping.
A loan is money that is borrowed by a small business to finance themselves, essentially giving them a surplus of cash in the short-term that they may not be able to gain through normal operations as quickly. However, it comes with the expectation that it will eventually be repaid (often with interest) and thus the issuers have a claim on it, which makes it a liability.
In the below example, we’ll work under the assumption that the business owner has had a loan approved from a local bank so that he could get his business running. This has the benefit of raising the amount of Cash he has to put towards his assets by $27,000, but now he also incurred debt in the form of a Loan Payable by that same amount:
Jan 1st: Cash $27,000
Loan Payable $27,000
It should be noted that even if the business owner spends all of $27,000 in the Cash, the Loan Payable will remain unchanged as it recorded the original amount received from the bank. However, that doesn’t mean that it will remain static forever. At some point, it will need to be paid down and loans have a habit of incurring interest payments that need to be recorded as well:
March 1st: Interest Expense $900
Interest Payable $900
March 29th: Interest Payable $900
Loan Payable $900
Cash $1800
As you can see in the above example, the loan resulted in accrued interest that was accounted for in the Interest Payable and Interest Expense after two months. At the end of the month, the business owner decided to put in $1,800 to pay off the accrued interest and then part of the loan. The amount of accrued interest is determined by the Interest Rate that is agreed upon by the lender and the owner and will vary.
This is a general and simplified explanation for how loans work. There are more complex ones that require a lot more work to manage, but for small businesses knowing this much will usually suffice. For more helpful advice, feel free to subscribe and stay updated with new posts to our blog.
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