Money in is not income
Cash from investors and owners arrives in the bank account, but it is not revenue. It is either debt, which must be repaid, or equity, which gives the provider ownership. The category depends on the terms, and getting it wrong distorts profit.
Convertible notes
A convertible note is a loan that is expected to convert into equity at a later financing. Until it converts, it is debt. Record the principal as a liability, accrue interest each period, and track the maturity date, the interest rate, and the conversion terms such as a discount or valuation cap.
At conversion, remove the liability, including accrued interest, and record the shares issued. Keep the calculation of the conversion price with the legal documents.
SAFEs
A SAFE, or simple agreement for future equity, is not a loan and has no interest or maturity date. It gives the investor a right to shares in a future round. How a SAFE is classified in financial statements depends on its terms and the accounting framework you use, and it is often treated as a liability rather than equity. Ask your accountant for the treatment, record it consistently, and keep a schedule of every SAFE with its cap and discount.
Capital contributions
When an owner puts money in without receiving a loan note or new shares, it is a capital contribution. It increases equity. Record who contributed, when, and how much, and be sure the books do not treat it as income. If the owner expects repayment, it should be a documented loan instead.
Dividends
A corporation that decides to pay a dividend should have board approval. On the declaration date, record a dividend payable and reduce retained earnings. On the payment date, pay it and clear the liability. S corporations and LLCs call these payments distributions, and they have their own rules about proportional treatment.
Retained earnings are not cash
Retained earnings is the sum of all the profits the company has kept, less what it has paid out. It is an accounting balance, not a bank balance. A company can have large retained earnings and little cash if profits were invested in inventory, equipment, or receivables.
Frequently asked questions
Is a SAFE debt or equity?
It depends on its terms and the accounting framework. It is often shown as a liability until it converts. Ask your accountant.
Do convertible notes accrue interest?
Typically yes. Accrue it as an expense each period, even though no cash is paid until conversion or repayment.
Can an LLC pay dividends?
LLCs make distributions. Whether they are taxable depends on the LLC's tax classification and the member's basis.